Thursday 15 March 2012

Investing in real estate: Real estate versus other investments

This is part 3 in my series on investing in real estate. In this part I will cover the differences and similarities between investing in real estate and other asset classes and the relative pros and cons.

You may be wondering why this is part 3 and not part 2 as it may seem to make more sense to decide whether you are going to invest in real estate before doing all the research behind it. I take a totally different point of view. I believe that only once you have the knowledge about what real estate investing involves / what your local market is like and what can you afford can you then really evaluate whether real estate investing is for you.

This part attempts to answer the question "should I invest in real estate or shares or keep my money in the bank".

Real estate versus shares

Both these investments have relative benefits and disadvantages versus each other. In my opinion they both form part of a balanced investment portfolio. In weighing up the relative merits of investing in either of these asset classes you need to consider the following


  1. The time you have to invest: Perhaps counter-intuitively real estate investment requires much less time on an ongoing basis. This is because with shares you should be constantly keeping up with all your investments filings / reports / press releases / competition / market environment. Real estate on the other hand tends to be very time intensive when you are looking for the property and then buy it and have to renovate and get it up to an appropriate standard. Once you have a tenant in place though and the cash flows start to come in, especially if you have a property manager (I swear by mine) the time commitment is very low.

  2. How much you have to invest: Buying a physical investment property is a big investment. For the moment I am going to ignore unit trusts. The deposit is (in Australia) typically ~20% of the property value (more for commercial properties) and then you are stuck servicing a relatively large loans whether you have cash inflows or not. Shares on the other hand can be bought in small parcels when and if you have the cash to invest. You can build up shareholdings slowly through dividend reinvestment plans or regular savings plans

  3. Time frame for your investment: While these are both inherently long run investments you will be penalised less with shares if you need your money in the short term. This is because a share trade should not cost more than ~$30 a trade in any jurisdiction however if you try and sell out of your property you are going to incur very high transaction costs including taxes, agents fees, advertising fees.

  4. What the market is like: There are a million cliche's that are going to disagree with me here including 'don't try and time the market' and 'it's time in the market that counts' and while they have some truth to them - I believe it is easier to make money by being a contrarian investor. That is - invest where it is not popular. If shares are going gangbusters then perhaps look at property which may be cheaper and vice verse.

  5. Tax implications in your jurisdiction: There is a very common line that I hear all the time - the tax consequences should not be a reason for your investment - and while this is true it should form part of your decision making process. The availability of negative gearing can effectively reduce the cost of funds associated with an investment to a very low amount meaning that even small capital returns can increase your return on equity substantially. This is not available in all markets so you need to check this carefully

  6. Your personality type: I have never seen this one written in books but I found it to be very true. If you're the type of person the gets worried when you see the value of your investments falling and cant get to sleep at night because your portfolio dropped 5% in one day then property could be a better class of investment for you. Because the market is (relatively) illiquid and no two properties are identical it is so much easier to ignore what is happening to the value of your investments on a day to day basis. Some may consider this sticking your head in the sand but if it gives you the 'sleep at night factor' and helps you stay the course in investing then it is something that should be considered.

Conclusion


Although I've presented the information above as an A versus B type proposition I think a healthy portfolio should have both shares and property. Too often people become skilled in only one investment (that is they spend the time only learning about one) and then believe that they can and should only invest in that but I believe that your portfolio and investment performance would be much better if you can master both and invest in each at the appropriate time for you


2 comments:

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