Before committing to any real estate investment, it is essential to know its advantages and disadvantages.
Experts love to invest in real estate. But why?
What they know that probably we do not know at real estate investment?
All investment options has their own set of advantages and disadvantages. Knowledge of this is essential to understand how one must expose self to each investment.
The proportion for which experts expose themselves to real estate investment varies.
Generally speaking, portfolio of a typical investors can limit real estate investment in range of 10%-70%.
So how to decide if our exposure should be 10% or 70% or some where in between?
This awareness will come is we know the advantages and disadvantages of real estate investment.
Investing for long term in real estate has great advantages.
It is not wrong to expect high returns from real estate property in long term.
As other investments, even real estate has its own control points.
The investment logic that applies to real estate is simple.
Buy a property which yields reasonable returns.
How to ensure that the real estate property will yield good returns?
Identifying good properties is a key in real estate investment. If invested properly, real estate investment can provide maximum returns with minimum risk.
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.
People generally put their money in real estate to buy homes for their self occupation.
In this case the risks are low as selling-pressure for profit booking is minimum.
But for investors who buy real estate properties to make profits, needs to take care.
For such investors it is essential to know the pros and cons of investing in real estate sector.
#1. What are the advantages of real estate investment?
We all are aware that real estate investments can be rewarding.
It one such investment options that can really generate the most consistent stream of passive income.
People like me who desires early retirement, cannot ignore this investment option.
But there are other inherent traits of real estate property that makes it my favourite:
What inherent traits I am talking about?
- I can see it, tough it and feel it before purchasing.
- It is possible to have a tailor made specification and find a matching property.
- Even before its purchase, it can almost guarantee that rental income will come.
- With passage of time, price of property will appreciate.
In addition to these, following are few key advantages of a real estate investment property:
#1.1 Allows Diversification of Asset
Real estate has almost no direct correlation with other popular paper based assets like equity, debt etc.
In fact it has a negative correlation with assets like 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 to find that, 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.
#1.2 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.
But the predictability of rental income is far more established than dividend income.
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.
#1.3 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.
#1.4 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, following tax benefits are applicable:
- Deduction U/S 80C (principal component-Max 1.5 lakhs).
- Interest paid against home loan is eligible for tax deduction U/S 24 (Max 2.0 Lakhs).
For second house, benefit U/S 80C is not available.
But complete interest component is eligible for tax deduction.
If interest component is 3.0 lakhs, then complete 3.0 lakhs is eligible for deduction u/s 24. But the second property will be considered as “deemed rented out”.
#1.5 Provides Leverage
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%).
The 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 properties generally appreciates faster.
Hence gives you an advantage using price leverage.
#2. Disadvantages of real estate investment…
Apart from other disadvantages, one that is most visible is its limitation of being so “price intensive”.
On one had, a normal investor can buy stocks with just Rs.500.
But in real estate investment, even Rs.5,00,000 may not be sufficient.
Moreover, a real estate property being an immovable asset, it is not east to both buy and sell it. How?
It is not easy to locate a property in your preferred location. It may not be easy to find buyers in a location where the property is located.
In addition to these, following are few key disadvantages of a real estate property investment:
#2.1 Capital gain tax is applicable
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).
#2.2 High Cost
The biggest disadvantages of real estate investment is high capital requirement.
Because of high capital requirement, buying and selling of property is laborious.
This is one reason why so many people resort to loans to buy real estate property.
These almost every alternate service class people dwell under the load of home loan. Living under loan for 1/3rd of your life often becomes a curse.
And why this is happening?
Because everyone wants to buy a home for self. Hence, price of real estate property is extremely expensive.
#2.3 High Cost of maintenance
Real estate also involves high management costs as compared to other investments.
The owner of the property not only has to maintain the internals of the property but must also pay the maintenance charges payable to the society.
This makes a real estate property more costly.
#2.4 Other disadvantages of real estate investment
- Real estate property is very illiquid. A large sum of money gets locked which is not so easy to redeem.
- To keep earning rental income, it is not so easy to find suitable tenants time an again.
- When market condition is not so good, market price of real estate property may also go down (temporarily).
Disclaimer: All blog posts of getmoneyrich.com are for information only. No blog posts should be considered as an investment advice or as a recommendation. The user must self-analyse all securities before investing in one.