The term “real estate investment” is ambiguous unless one specifies what kind or real estate they are speaking about. For investment purposes, there are at least a dozen ways for an average investor to bring real estate assets into a portfolio.
There exist real estate-backed ETFs (exchange-traded funds) and similar instruments that are virtually identical to buying shares of a common stock or a mutual fund. This kind of real estate exposure is typically not what investment texts and experts mean when they talk about real estate investing. For most purposes, putting money into this sector involves the actual purchase of land or structures or both.
When one buys a piece of commercial or residential real estate, there are notable advantages and disadvantages that should be examined before a commitment is made. Following are the pros and cons of real estate investment, in a general sense.
Advantage (1) – Sweat equity
One of the best things about owning real estate is that the value of the asset is at least partially controllable by the owner. In other words, an owner can repair a roof, put on a fresh coat of paint or otherwise beautify a house or building. Even if contractors need to be hired, whatever is done to improve a property has the potential to increase the asset’s value proportionally. Unlike stocks, bonds and precious metals, an owner of real estate has some power over the improvement of the investment itself. This advantage applies to very few asset classes except for real estate, classic cars, and a few types of collectables and antiques.
Advantage (2) – Diversification
Many investors diversify their portfolios by purchasing stocks and bonds in different market sectors or by acquiring precious metals as a hedge against inflation. Fewer consider real estate as a way of diversification, partly because the cost of entry is higher but also because the average investor tends to not know very much about the RE market. There is a certain amount of “real estate phobia” that certainly has an impact on the willingness of many to purchase real estate.
But, even a single, small real estate asset can be an ideal way to truly diversify a portfolio that is otherwise filled with stocks, bonds and a smattering of gold and silver.
Advantage (3) – Not tied to securities markets
Compared to the securities markets, real estate is generally untied to what the major world markets do. Stocks, bonds and precious metals go their own way and have their own cycles, but real estate assets are for the most part isolated from the ups and downs of Wall Street fortunes. In this respect, real estate as an investment is similar to gold and silver in that it can be on an upswing when the stock market is headed south. For example, in inflationary times, real estate investments tend to do quite well, even when other asset classes are performing poorly.
Disadvantage (1) – RE is a Challenge to Acquire
For reasons of cost and availability, it can be difficult to buy several real estate assets that have diversity amongst themselves. Because the average cost of just a single piece of real estate is much higher than the cost of a group of stocks or even a few ounces of gold, RE assets can be a challenge for the average investor to buy, especially when more than one is required for a balanced portfolio.
Disadvantage (2) – Management and Maintenance Costs
Whether an investor hires a management company to take care of day-to-day administration of property or not, there is a significant cost to maintaining a property and dealing with tenants. This type of expense, in both time and money, is rather unique to real estate and needs to be considered beforehand.
Disadvantage (3) – Measurement of results
Because every real estate asset is, to some extent anyway, unique, it’s nearly impossible to measure performance on a regular basis. For example, if a small office building in a major city returns 8 percent on investment for a given year, is that higher or lower than it should be?
There is no answer because that particular office building in that exact location can’t be compared to one just like it across town, or even to a different one nearby. Measuring the performance of RE assets is somewhat of a guessing game, especially for large commercial properties that are one-of-a-kind structures.
As with any other asset acquisition, one should do considerable research before committing money to a real estate asset. While just one RE asset can be a huge plus for a standard portfolio, it should be stressed that real estate is unique in many ways and demands more due diligence than most other kinds of investments. By moving slowly, doing research, and consulting with experts, one can be more certain that a particular real estate purchase is a wise move.