Real estate has historically been considered a very good investment. Stocks for instance are known to fluctuate but investing in real estate has proven to be very stable.
But like any other investment, real estate investment has its share of pros and cons besides the significant profits one can earn from real estate.
As an investor or a hopeful investor, due diligence is very vital whether you are going it alone or are working alongside real estate professionals.
There are typically two ways of earning from real estate. The first one is by purchasing property and reselling it at a profit, probably at a later date when it shall have increased its value, or after improving it, thereby increasing its value.
Secondly, one can earn from real estate by renting it out and earning stable passive income from it. Whichever the strategy you decide to employ, both methods have their advantages and disadvantages.
Here are some of the advantages and disadvantages of real estate as an investment.
Advantages of Investing in Real Estate
1. Potential for Profits
There is great potential for profit with real estate if you can purchase a property at a price low enough for you to make a significant profit when sold to a buyer.
For instance, some investors purchase property and flip them, which is likely to result in very high profits.
One can purchase property that requires little to no repairs then update it and resell it at a higher price. In such a scenario, it is important to be cautious to pick a property that will require little repairs, so that you do not spend a lot of money updating the property.
2. Continuous Income
Investors can make money from renting real estate. Rental property usually provides continuous steady income over a relatively long period. To maintain this income, the investor should manage the property well and make sure it is always maintained in very good condition.
3. Real Estate Hedges Against Inflation
Inflation refers to a decrease in your purchasing power. An inflation hedge protects you from this. Hedging against inflation means investing in an asset whose value is expected to remain constant or increase over a specified period.
Real estate reacts proportionately to inflation. As inflation increases in the economy, housing values and property rents go up. That is why this asset class is considered a hedge against inflation.
Investors add real estate assets to their portfolios to shield their whole investment portfolio against inflation.
4. Financial Leverage
When one purchases real estate, they attain financial leverage. One who owns real estate can borrow money (mortgage, home equity loan, or a personal loan) using the property as collateral.
Compared to other investments, the investor contributes a smaller proportion of the capital outlay when purchasing real property.
The buyer will only be required to put down a small fraction of the purchase price as down payment, say 20%.
Since real estate is generally expensive, their purchase can be structured in such a way that it is safe to buy it, and affordable to the purchaser.
You would purchase a tangible asset whose value appreciates over time, and primarily pay for it using other people’s money.
5. Potential to be Improved
When you buy a stock, you would hold it for some time and probably sell it for a profit. The success of this endeavor depends on the management of the company and their general corporate success, all of which are out of your control as an investor.
When you own real estate, it is directly under your control. Even though there are external factors that you may not control such as the economy, demographic changes, and natural occurrences, there are so many other aspects you can control about the physical property and the users.
Having grasped proper management of the asset and your investment portfolio in general, you can significantly improve the value of your asset and make it fetch you even more money.
For instance, you can carry out the repair and maintenance of your rental property and have it fetch more rent, or buy the property and improve its value before reselling it.
6. Tax Benefits
Real estate offers great tax incentives on almost everything from apartments, rental properties, vacant land, industrial facilities, and commercial buildings. A real estate investor can make substantial tax savings, and in some instances, tax sheltering.
Some of the real estate investment tax benefits include deductions, capital gains, depreciation, passive-income, and pass-through deductions, among others.
Deductions are tax write-offs geared towards rental properties. They include costs associated with mortgage interest, operating expenses, property tax, depreciation, and repairs.
Capital gains are the profits homeowners make when they sell their property. Capital gains exclusion is the biggest tax benefit for a real estate investor.
They can be used more than once to allow the property owner to be exempt from paying taxes on profits up to a certain amount that they have earned from selling their home.
7. Credit Access
The additional income investors generate from real estate may give them access to more credit, depending on many other factors. In typical situations, lending institutions give more credit to people who earn more income.
8. Less Complicated
When you are just starting to make investments, it can be difficult to understand everything you need to know concerning the asset you are investing in and start making profits.
Many investments have complex concepts and complicated algorithms that are difficult to crack and fully understand.
Real estate is relatively easier to understand since it is just a matter of purchasing, selling, and leasing or renting real property, which arguably everyone is familiar with to some extent.
Investing in real estate can be easier to manage compared to other investment assets whose information has to be decoded scientifically or mathematically.
Disadvantages of Investing in Real Estate
1. Low Liquidity
Real estate is a very low liquid asset. The proprietors may not be able to sell their property when they want to, and at the price, they intend to sell it to make a profit from the sale.
This mostly happens when the market is declining. When this happens, remember the monthly mortgage payments still have to be made.
Many other investments are relatively more liquid and can be sold at a profit within a very short period.
If real estate was to be traded in such a short period, chances are that it will be sold at a price below its market value, resulting in losses to the owner.
The real property would have to take a substantially longer period in the market during which money is spent advertising and marketing it.
2. Large Capital Cost
This is perhaps the biggest disadvantage of investing in real estate. Because of the large capital outlay required, purchasing real property is quite a task.
For this reason, many real estate investors resort to using loans to acquire real property. Servicing mortgages are ultimately expensive. One even risks losing their property if the real estate market dips and they are unable to make their monthly mortgage payments.
3. High Maintenance Costs
Once an investor has purchased property, it has to be maintained, repaired from time to time and rehabbed regularly. With time, the maintenance costs may increase and reduce the profits the investor earns from the property.
Replacing the roof or HVAC for instance can be quite costly especially for large buildings like apartments. If the repairs are not conducted within a certain time frame as determined by the local authority, the proprietor may be subject to the payment of huge fines.
4. Market Inefficiencies
Market inefficiencies can be used to the advantage of the investor. However, they can also be detrimental to the property’s potential to generate profits.
Since real estate is characterized by speculation, investors purchase a property based on minimal information on many cases.
Sometimes they may not even know whether the deal they have made is a good one until the transaction is completed and they get to inspect the property.
On some occasions, dealing with rental properties can present so many uncertainties. The performance of the economy keeps fluctuating.
Besides, the demographics of the place where the property is located can dwindle and become difficult to predict. These can affect profits.
5. Applicability of Capital Gain Tax
One an investor has sold their property at a higher price than that at which it was bought, capital gain tax is applicable.
If the property is sold within three years after its purchase, short term capital gain tax is levied on the profits depending on one’s income. If the property is sold more than three years after its purchase, long term capital gain tax is applicable.
6. Financial Liabilities
Investing in real estate involves taking a lot of financial liabilities since investors rarely have the cash to exclusively pay for the property during purchase. Consequently, many take out loans.
If for instance, you have acquired property to sell it, if you are not able to find a buyer sooner, you will be stuck with the property and the debt which you have to continue paying until the property eventually sells.
If you are servicing a loan using a rental property and you can’t find a tenant sooner, or the tenant fails to pay their rent, you will service the loan regardless. This is a huge financial liability to the investor.
7. Difficulty in Finding and Retaining Good Tenants
If you decide not to sell your real property. You’ve got to look for good tenants for the property.
As an investor, you have the option to look at the tenants yourself or contract a property management company to do the work for you.
The property manager will find good tenants, manage them, and handle all the paperwork, but your expenses will increase because you will have to pay handsomely for those services.
If you decide to find the tenants for yourself, be prepared to carry out tenant-screening before signing a contract, which is a complex process.
If you encounter a problem mid-occupancy, you will have to pay a lawyer to have them evicted. The process is quite involving and can be tedious to the investor.
Real estate is an unpredictable game where you either stand to reap massively from or lose your money to if the market and circumstances turn against you.
You must keep in my that regardless of how much money you spend improving your property and making it lucrative, the market still decides greatly how much it is worth and how much you can earn from it.
Therefore, its advantages and disadvantages are more out of your control than they are your own making as an investor.
Real estate is a very lucrative sector to invest in. Given the complexity of the business, investors often have to carry out a great deal of market research before deciding to put their money into real estate investment.
This has to be done to successfully navigate through the pros and cons of real estate investment.