Real estate, a traditional asset class which is considered a safe option for investment giving best returns in long term has been the preferred choice of investors since ancient times. This asset class comes with many advantages as well as disadvantages. Let us learn about pros and cons of investing in real estate properties in this post.
Investing in Real Estate
Investing in this asset class means you are investing in properties. There are mainly two types of properties. Residential properties like houses, rental properties and non- residential (commercial) like shops, office spaces, malls, etc.
Advantages
Investment in real estate properties has many advantages which are mentioned below:
It is a Tangible Asset
Real estate properties are tangible assets. You can touch them, feel them and live in these assets. Having real estate properties gives you more confidence and control as compared to shares or equities, which are non- tangible assets and you do not have much control over them.
You can Have Rental Income as well as Capital Gain
Real estate properties give you two types of income. One is rental income and second is capital gain. You can give your residential or commercial properties on rent and can obtain steady rental income from your houses, apartments, shops, office spaces, etc. While you are getting steady income from your properties, the market price of the real estate properties also increased over the time and you get long term and short term capital gain when you sell the properties.
Great Returns
It is seen that real estate properties give great returns in the long run. Although the returns are not guaranteed, if you have invested in a property which is at good location or the locality where your property is situated, is developed over time, the chances are that you can gain manifold returns on your investment.
Tax Advantages
Investing in real estate properties also provides many tax benefits. You can deduct several expenses associated with the properties like your property tax, cost of maintenance, cost of repairs, expenses incurred in marketing the properties, etc. When you sell your property, then the gain is not taxed as income tax but as capital gain tax, the rate of which is lower than income tax.
One more benefit of real estate property is that if you take home loan on a property, then you can avail tax benefits on the loan taken. The Indian government has always shown a great inclination to encourage citizens to invest in houses. This is why a home loan is eligible for tax deduction under Section 80C.
The principal portion of the EMI paid for the year is allowed as a deduction under Section 80C. The maximum amount that can be claimed is up to Rs 1.5 lakh.
The interest portion of the EMI paid for the year can be claimed as a deduction from your total income up to a maximum of Rs 2 lakh under Section 24.
Ability to Leverage Funds
Real estate properties require huge capital to invest. But the plus point is you can leverage the funds to buy properties. Leverage of fund means you can use other people’s fund to invest in real estate. In this case you can take loan from banks or other financial institutions to buy property. You will have to spend only a percentage of total price of property to add the property in your portfolio and the rest of amount will be paid by the bank or financial institution. The best part is that, If the property you are baying is a rental (residential or commercial) property, then you don’t even need to pay EMIs from your pocket. Full or part of EMIs will be paid by the tenant and you will enjoy the ownership of the property.
Provides Hedging Against Inflation
Real estate properties are known for providing protection from inflation. When the prices or goods and services keep rising, the prices of real estate properties and monthly rents also rise. So, the real estate properties provide you steady monthly income as well as good capital appreciation which protect you from inflation.
Passive Income
Real estate investment has the ability to give you steady passive income. If you invest in good rental properties, you will get monthly cash flow in the form of rent or lease from the properties without making extra effort. Commercial properties are better than residential properties for providing rental income.
Provides Long Term Security
Investing in real estate properties for long term gives you financial security as well. Long term capital gain from the real estate properties provides you financial security when there is a need of finance. You can get loan also against your property in emergency situations.
Disadvantages
More Work as Compared to Equity
There is a lot of work in buying, maintain and selling the properties. Searching for a right property is an uphill task. There is a lot of effort goes in maintaining the properties, especially the rental ones. You need to arrange mason, plumber, carpenter, electrician, etc. to attained day to day issues. Sometimes, when you have invested in several properties, you may have to deploy a property manager to look after the day to day problems related to properties. Then, engaging the brokers, advertisements, etc. is an added task, w.r.t. the real estate. In comparison to real estates, investing in equity require negligible work and attention. Once you have invested in stocks, you can relax till you sell the equities. The businesses take care about their performance and the value of their shares increase, if they do well.
Huge Capital is Required for Investment
This is one of the biggest drawback of investing in real estates. Real estate properties require huge capital to acquire. This creates barriers to entry for small investors, who cannot afford to buy properties. Even if one has arranged the required capital and invested it in some property, the waiting period is very long to gain profit from the investment. The opportunity cost of the capital is another factors which should be kept in mind before spending such a huge amount in a property. Opportunity cost of capital is the potential return from the capital if it would had been invested in some other business or asset class. Let us understand opportunity cost by the following example.
Suppose you have invested INR 50,00,000/- in a residential property and you are getting 8% capital gain annually. If you would have invested this amount in some business and you would have gained 10% annual return there, then the opportunity cost in this case will be 2% of Rs. 50,00,000/- annually, i.e., Rs. 1,00,000/- annually.
Highly Illiquid Asset Class
Real estate assets are highly illiquid. Getting your money back by selling the property is very difficult. As the upfront capital requirement for buying a property is huge, buyers for the properties are not easily available. You may have to go through a tedious process of advertising your property or seeking help of brokers, etc. The waiting period for realizing gain from your property may be too long and you may not be able to get money from your property when you actually need it.
Lack of Transparency
Lack of transparency is a big issue in case of real estate investments. In most of the cases you never know the real price of the property and the seller tells inflated price. There is no mechanism available to cross- check the price of the property and you end up paying unjustified price for the property. In some cases, the seller demands cash amount as some percentage of price which is not actually shown in the transaction. It means your hard earned money may be converted in black money in this process. These are some of the biggest drawbacks of investing in real estate and one should be careful while making any real estate purchase.
High Transaction Costs
There are high transaction costs involved with the real estate investment. A seller may have to end up paying as much as 5% to 6% in addition to actual price of the property. This additional cost may be in the form of brokerage fee, stamp duty, lawyer’s fee, etc.
Lack of Diversification
As you put substantial share of your investment in some real estate properties, the opportunity of diversifying your investment is missed in this case. Your money is invested in few properties only (may be only one or two) and is not diversified.
REITs: An Alternate Method to Invest in Real Estate
There is an alternate method of investing in real estates through which you can invest in this asset class without actually owing them and even with very small amount of money. This asset class is called RETI. REIT stands for ‘Real Estate Investment Trusts’.
REIT is created by a corporation or trust which uses money of many investors (mostly small) to buy and operate property. The income earned by these properties is distributed among the investors. REITs are purchased and sold on major exchanges, like other stocks.
The main advantage of REITs is that they are highly liquid. You don’t need a real estate agent to sell them as they can be traded in exchanges similar to stocks.
Also Read: Indirect investment in Real Estate with small amount of money! to know more about REITs
Conclusion
Real estate is a traditional asset class which is a preferred investment avenue since ages. It has gained trust of investors due to many advantages it offers. Some of the advantages are long term security, good capital gain, chances of earning passive income, tax advantages, etc. However, real estate investment also comes with some disadvantages like it is highly illiquid, lack of transparency, high transaction costs, huge upfront capital requirement, lack of diversification, etc. You should therefore consider above things carefully before investing in real estate properties. If you can afford buying the real estate properties and take into consideration all the above discuss points, then this asset class has potential to make you rich and financially secure in the long run.
