Limitations of real estate as asset class

Maduka Nweke

Like any investment, there are pros and cons to investing in real estate in addition to the potential for significant profits. As a result, due diligence is very important, whether you do everything yourself or use industry experts to help.

An asset class is a group of securities that exhibits similar characteristics in the marketplace and is subject to the same laws and regulations. The three main asset classes are equities, or stocks; fixed income, or bonds; and cash equivalents, or money market instruments. Some investment professionals add real estate, commodities, and increasingly, cryptocurrencies such as Bitcoin, to the asset class mix.

Nonetheless, because of the nature of real estate, it has got a lot of challenges that bridge its potential of being an asset class. Among these hurdles include but not limited to legal difficulties. Investing in real estate has the potential of being very confusing because it requires that you are fully aware of the laws in each jurisdiction that you own property. Some jurisdictions may even enforce land ceilings which can make the investment risky. The legal difficulties can become much more complex if the investor is investing in commercial real estate.

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Many a time people rush to own edifices without considering how to sustain the initial aesthetics. These kind of people fail to know that the cost of maintaining the property can cause the investor to lose money on the investment.

In larger cities, property taxes can be so high that it will be very difficult to resell the house at a higher value. If the owner of the property is renting out the units, maintenance costs can take large chunks out of the income stream.

If the owner does not personally know the tenants before renting out the units, they run into the risk of renting the space out to someone who will not take care of the unit, causing the owner to put large sums of money into repairs.

Furthermore, other costs such as electricity and heating will also add up. In a very developed and established economies, taxes are more for the rich compared to the poor. This is because, the government will not like to impoverish the poor the more instead, the poor will be allowed some breathing spaces to enable them care for their other miscellaneous needs.

So in that parlance, before investing in real estate, the investor should always factor property taxes into their valuation of the property. In larger urban cities, property taxes can be significant and may cause the investor to lose a big chunk of their profit. Property taxes will vary depending on which city or state the property is purchased in. Therefore, the investor should always consult with city officials before investing in property.

Anybody venturing into real estate must bear in mind that real estate has a higher transaction costs. In that vein, when purchasing shares of a stock, the transaction cost for the trade is very low, often just a few dollars. But when purchasing real estate, the transaction costs are considerably higher.

This is unlike other types of investments, real estate transaction costs can significantly affect the value of the investment and make it more difficult to turn a profit. Most people also rush to real estate for business to eke a living.

Their believe is that once they have business, they will always make money. Some of the investors into real estate think that unlike many investments that have high liquid, and can be bought and sold for a profit in a fraction of a second, as with high-frequency stock trading; the real estate investments are comparably illiquid, because properties can’t be quickly and easily sold without a substantial loss in value.

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Real estate investors must be prepared to own a property for months and years, especially if it will be leased out. Many a time, people will buy into a property without knowing that the property should be rehabilitated and the maintenance sustained. They don’t know that once an investor purchases a property, it must be rehabbed, maintained, and managed.

Financing payments, real estate taxes, insurance, management fees, and maintenance costs can add up quickly, especially if the property sits empty for extended periods of time.

One of the greatest problems of real estate is that fact that you can just judge a property by the   outside aesthetics. Even as people know that you don’t judge books by their cover, it is not enough for one to believe that because the beauty of the outside building indicates its solid footing.

As it is already discussed above, the market’s inefficiencies can be advantageous to investors. But here we want to also mention the disadvantages, which can be illustrated by investors purchasing properties sight unseen at auction.

The most aggressive investors purchase real estate based on minimal information, and don’t know whether they’ve made a good deal until paying for the property and then inspecting the property. Likewise, investors with rental property deal with fluctuating demographics and volatile economies, which can either add or take away from their bottom-line profits.

Real estate investing involves dealing with market inefficiencies, which can be mishandled to result in financial ruin. Because of capital intensity of real estate business, a lot of people go through mortgage facilities to meet the financial muscles needed to develop their projects.

The system in use by developers doesn’t afford them the use of their meager income to execute so the system creates liabilities. This is why real estate investing involves taking on a great deal of financial and legal liability. All the disadvantages mentioned above add to the liability a real estate investor takes on when purchasing, financing, rehabbing, leasing, managing, and maintaining a property.

Even though investment properties may be in a corporation, there are often personal guarantees associated with the business, and the risk of losing the income and profits generated by the company. This where the asset class categories come to play.

Asset classes and asset class categories are often mixed together. Financial advisors view investment vehicles as asset class categories that are used for diversification purposes. Each asset class is expected to reflect different risk and return investment characteristics, and performs differently in any given market environment.

Investors interested in maximizing return often do so by reducing portfolio risk through asset class diversification. Financial advisors focus on asset class as a way to help investors diversify their portfolio. Different asset classes have different cash flows streams and varying degrees of risk.

Investing in several different asset classes ensures a certain amount of diversity in investment selections. Diversification reduces risk and increases your probability of making a return. If the property is easily convertible to rental units, the owner of the property can earn a steady income stream in the form of rent.

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Depending on the geographical location the property is located in, the earnings can be quite significant.  For example, urban city centers or towns with colleges and universities tend to offer the highest income streams because the demand for rental units is always high. But other things apart, there is security of investment because owning property can offer the investor a sense of security because the value does not tend to fluctuate as much as other assets such as stocks and bonds.

However, this does not mean that the investor will always break even or earn a profit on their investment.
Although housing prices do not tend to fluctuate in the short term, they may increase or decrease in value in the longer term. Therefore, it is important for the investor to thoroughly research the area before making a purchase.
When you start investing, it can be difficult to understand everything you need to know to make a profit. Many types of investments rely on abstract concepts and complex algorithms, which are especially difficult to understand.

Real estate, on the other hand, involves the purchase of physical property and most people are familiar with real estate to some degree. Investing in real estate can be much easier to understand than complex investments developed by mathematicians. After you buy a stock, you hold it for a period of time and hopefully sell it for a profit.

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The success of the stock depends on company management and their corporate success, which is out of your control. In contrast, real estate investments are directly under your control. Though you can’t control demographic and economic changes, or acts of God, you can control many things relating to the physical property and tenants. With good management of your overall real estate portfolio, you can tangibly improve the value of your investment and build wealth.

Real estate is one of the few assets that reacts proportionately to inflation. As inflation goes up, housing values and rents go up. Though real estate in general is a good hedge against inflation, rental properties that are re-leased every year are especially effective, since monthly rents can be adjusted upward in inflationary periods. For this reason alone, therefore, real estate is one of the best ways to hedge an investment portfolio against inflation.

Unlike the stock market, the real estate market is full of inefficiencies. There is a lack of transparency relating to individual property values and also the strength of different markets, which means that real estate investments have the potential for very high profits.

The post Limitations of real estate as asset class appeared first on The Sun Nigeria.

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