Many investors and traders consider investing in real estate as an alternative investment class. It’s also normally held as a part of a larger portfolio. Also, it has numerous qualities than can enhance the return of a bigger portfolio. It can even reduce portfolio risks at the same level of return. This investment is also usually present in well diversified portfolios.
We have listed some of the things you must know if you’re planning to invest in such things. Real estate has its pros and cons, and you better arm yourself with the knowledge you need. Read on!
Real Estate: Pros
When it comes to your portfolio, the good aspects in terms of asset allocation will be well documented. Real estate returns have a slightly less connections to other asset classes, such as stocks and bonds.
In short, it adds to the diversification of your portfolio.
When it becomes a part of your portfolio, real estate gives you the power to get higher returns for a level of portfolio risk. Similarly, you could maintain your portfolio returns as you decrease risks.
Remember that returns from real estate are directly connected to the rents that tenants give. Some kinds of leases contain provisions for rent increases, which need some indexing to inflation.
In other cases, rental rates increase whenever a lease term expires. Then, the tenant is renewed. Either way, real estate income usually increases more quickly in certain environments. This allows you to maintain your real returns.
Real estate is a tangible asset. Therefore, you can do things to it to increase its value. You can improve its performance.
For instance, you must replace leaky roofs, improve the appearance of the building, and re-tenant it. You will have greater degree of control over its performance than other investments.
Real Estate: Cons
When it comes to private real estate market, costs are quite larger than other investment classes. Purchasing larger real estate classes proves it to be more efficient. That is because you can spread the transaction costs throughout a much larger asset base.
Moreover, it becomes more costly since it demands constant maintenance.
Real estate demands ongoing management at two levels, although they come with some exceptions.
First, you must require management that deals with day-to-day operations of the property. Second, you need strategic management to see the longer term market position of your investment.
Sometimes, one group combines and handles the functions of the management. It will definitely require time and money.
Difficult to Acquire
Building a meaningful, diversified real estate portfolio can pose challenges to you. You need to make it in a variety of locations across different asset classes. However, these can be out of reach for some investors.
On the other hand, you buy units in a private pool or a public security. Diverse portfolio normally backs these units.
Cyclical (leasing markets)
Real estate markets are like other asset classes. It has the leasing market cycle and the investment market cycle. Leasing market has the market for space in real estate properties.
The supply side dictates the conditions of the leasing market. This side pertains to the amount of space available. Another side is the demand, which is the size that tenants require.
When the demand for space increases, of course, the vacancies will decrease. It lessening of space will then cause an increase in the market rents. When rents hit economic levels, developers gain profit. This happens since the need to construct additional space grows. Supply then can meet demand.
Cyclical (investment markets)
This market moves in a different way from the leasing market. On the demand side, there are investors who have the money to invest in real estate. On the supply side, there are the properties that owners bring to the market.
When the supply of capital looking for investment grows, then the prices of the properties rise. As the prices increase, more properties come to the market to meet demand.
These two cycles have independent cycles, but each of them usually influences the other. For example, when the leasing market goes downward, rents’ growth should decrease. When investors face decreasing rental growth, they might think prices too high. They might therefore stop buying. When the capital seeking real estate drops, prices fall.
Even if many do not advise timing the market, you must still be aware of the market stage. This is true especially when you buy. Also, this is important when you consider the performance of the property as it moves through cycles.
Measurement of Performance
High quality benchmark does not exist in the private market. That means you cannot compare your portfolio results to anything.
Consequently, it is difficult to measure risks. In the stock market, you can easily determine risks and returns. But you will find it more challenging to measure the performance of the property market.
Investing in real estate can become a very profitable venture. However, if you are not aware of the aforementioned pros and cons, it may be detrimental. Remember that in any kind of investment, you need to avoid mistakes. You can avoid these mistakes by arming yourself the necessary knowledge.
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