Real Estate Investment Advantages and Disadvantages

By | April 17, 2012

It is fairly common for institutional investors to invest in real estate. Although the proportion varies widely. The proportion of portfolio in the tune of 10 to 20 percent of assets in real estate is common. If we consider a long term investment, then returns in real estate lies between that of stocks and bonds. Even the level of risk falls between that of stocks and bonds.

Advantage of investing in real estate

The advantage of investing in real estate is particularly lies in the fact that it has almost no corelation with other asset class like stocks, bonds etc. This means that the growth in value of your real estate portfolio bears little relationship to the growth of these other asset classes. According to some, there is a slightly negative correlation with asset classes (stocks & bonds). It is common to notice that when stock market is doing bad then return in real estate investment will go up. This effect is known as a benefit of diversification.

A second theoretical advantage of investment in real estate is found in the otherwise-cyclical behavior of real estate. The relationship between the earning yield and the economic cycle would differ significantly from that of shares. In a situation where an economic boom is at its end, property would still yield good returns for some time, as opposed to shares.

The advantages of investing in property shall also include: the relatively high and usually reasonably stable income return (rental income minus financial costs and administrative expenses). The possibility that inflation is compensated by an increase in rental income and / or an increase in the value of the property.

Disadvantage of investing in real estate

The disadvantages can be high capital requirement, buying and selling is rather laborious and rather expensive, significantly high administrative costs per unit as compared to capital invested in shares.

There are various ways of Investment in real estate. An investor may directly own like an office building or a unit in a shopping center. He can either enter into a partnership with other investors, or can afford to buy property through REITS.

The first method is rather inflexible: it can only be done if you have big capital for investment. The second method is very widespread these days. A smaller amount of capital is required to invest in REITS and you can get the same leverage of full fledged real estate investment.

There is a wide choice of investment in property, both regional (Mumbai, New Delhi, Bangalore, United States) and sectoral (malls, offices, distribution halls) choices.

Regarding the reported returns of investment in properties it is further noted that they consist of two components: the income return (rental income minus administrative and financing costs) and capital growth (difference between value of the premises at the beginning and end of year .) The last component is dependent on the method of valuation (We know only what the exact value of a property is, if it sells.)

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