It is common for expert investors to invest in real estate. It is also a fact that there are both advantages and disadvantages of real estate investment. The proportion for which experts expose themselves to real estate varies. The proportion of portfolio’s exposure to real estate can vary from 10-70%. Investing for long term in real estate has great advantages. It is not wrong to expect very high returns from real estate property in long term. As other investments, even real estate has its own control points. Investment logic in real estate is simple. Buy a property which yields reasonable returns. Investors must know how to evaluate yield of real estate property. Identifying good properties is a key in real estate investment. If invested properly, real estate investment can provide maximum returns with minimum risk. When invested correctly, real estate can make good money. But on flip side, bad real estate can really eat away money. It is essential for investor to be aware of both advantages and disadvantages of real estate investment.
Advantages and Disadvantages of Real Estate
Allows Diversification of Asset
Real estate has almost no direct correlation with other popular asset class called equity. In fact there is a negative correlation with assets stocks, gold etc. This means, the first benefit that real estate provides is diversification of asset. Growth in value of real estate portfolio bears little relationship with other asset classes. It is common, when stock market is doing bad then real estate will perform well. In a situation where an economic boom is at its end, real estate property would still yield good returns.
Instantaneous Dual Income
Like stocks, real estate also provides possibility of dual income. Stocks provides short term income in form of dividend. Real estate provides rental income in short term. Predictability of rental income is far more than dividend. In long term both stocks and real estate provides capital appreciation. Stock can provide faster appreciation. Real estate provides slower but steadier capital appreciation in long term.
Great Inflation Hedge
A combination of rental income and value appreciation certainly beats inflation. There is not other investment which can beat inflation as consistently as real estate property. Actually it is not fair to consider real estate as only inflation hedge. If invested properly, returns from real estate property outsmarts inflation by miles.
Saves Income Tax
If investment is real estate is made availing home loan, then tax benefits can be claimed. For first house which is self occupied, tax deduction U/S 80C (principal component-Max 1.0 lakhs) is applicable. Interest paid against home loan is eligible for tax deduction U/S 24 (Max 1.5 Lakhs). For second house, benefit U/S 80C is not available. But complete interest component is eligible for tax deduction. If interest component is 2.5 lakhs, then complete 2.5 laks is eligible for deduction u/s 24.
On sale of property at higher price capital gain tax is applicable. When property is sold within 3 years of purchase short term capital gain tax will be applicable as per ones income slab. But when property is sold after 3 years of purchase, long term capital gain tax of flat 20% is applicable (after indexation). Indexation gives huge tax benefit to the investor. This is not over, real estate investment gives more tax benefits. Suppose you sold a property at Rs 50 lakhs where your profit was Rs 30 lakhs. If you invests these Rs 30 lakhs in another ‘residential‘ property withing 2 years then the money (profit) will not be taxable.
Use of leverage in real estate investment can have mixed reactions. It has both advantages and disadvantages.
CASE-1 > Suppose you bought a house worth Rs 50 Lakhs. Out of Rs 50 Lakhs only Rs 10 lakh you paid from your pocket (20%). Balance Rs 40 lakh was paid using home loan (EMI Rs 40K per month). Suppose in one year the property value appreciates to Rs 55 lakhs (10%). What will be your profit? Profit will be approximately Rs 5,00,000 – 40,000×12 (EMI) + 60,000 (Principal paid) = Rs 80,000 (profit).
CASE-2 > Instead of buying property of Rs 50 lakhs, suppose you decided to buy within your means. Hence you bought a property of value Rs 10 lakhs. Suppose in one year the property value appreciates to Rs 11 lakhs (10%). What will be your profit? Profit will be approximately Rs 1,00,000 – 10,000×12 (EMI) + 15,000 (Principal paid) = – Rs 5,000 (loss).
This is the benefit of using leverage. Expensive property appreciates faster. Hence gives you a advantage.
High Cost & Low Liquidity
The biggest disadvantages of real estate investment is high capital requirement. Because of high capital requirement, buying and selling of property is laborious. On one had even Rs 500 can be used to buy stocks. But real estate property does not come so cheap. This is one reason why so many people resort to load to buy real estate property. Real estate also involves high management costs as compared to stock investment. High cost is only aspect of real estate property. It also locks high capital for long time. Liquidity of funds gets severely affected in real estate investment. It is not to sell properties easily and quickly.