Pros and Cons of Real Estate Investments

Real estate is an interest in land or property. The interest can either be a leasehold interest or an ownership interest. In case of leasehold interest, the owner of land or property passes some of the rights to a tenant in exchange for a rental payment. On the other side, an ownership interest exists when an investor is entitled to full rights of ownership of land and should also take full responsibility of the risks associated with it. There are several benefits of having a real estate in your portfolio. Some of them are discussed below.

It helps in generating returns – By adding real estate in a portfolio, you can maintain a portfolio return while minimizing your risk to a lower level. Therefore, as a part of your portfolio, it enhances yield for a given level of risk.

It hedges the risk of inflation – returns from real estate are directly associated with the rental payments that are received from tenants. In some leases, rent increases in proportion to an increase in inflation. Whereas in other cases, rentals are revised whenever term of the lease expires and tenant is renewed. Either way, income generated from real estate grows faster in an inflationary environment and allows investors to maintain their real returns.

An investor can significantly influence the performance of real estate investments – As real estate is a tangible asset, an investor can renovate it or can do a lot of things to increase its value and to enhance its performance. Therefore, an investor has a greater influence over the performance of real estate investments as compared to other investments.

Real estate investment minimizes the risk through Diversification – Returns generated from real estate investments have very little correlation with the returns generated from other investments like bonds and stocks, and thus, helps in the diversification of your portfolio.

On the other hand, there are certain characteristics of real estate investments that require special consideration as they have some drawbacks associated with it. These are explained below.

High transaction and maintenance cost – Whenever you plan to invest in the real estate market, the transaction cost is comparatively higher as compared to other classes of investments. Therefore, Your Personal Financial Mentor guides you to purchase larger real estate assets in order to spread the cost over a wider asset base. Also, the ongoing maintenance cost of real estate investment is huge.

Real estate investment needs continuous management – These investments require continuous management to consider their long term position in the market. But management is costly even if it is done by single investor; it still requires resources and reasonable time.

It is not easy to acquire – It is not an easy job to build a well diversified portfolio of real estate investments. An investor is required to purchase in different geographical locations and across different classes of assets, which is not quite possible for many investors.

No benchmark is available to measure its performance – Risks and rewards associated with the stock and bond investments are easily determinable because of the established stock market but no standard benchmarks are available to measure the performance of real estate investments

Categories: Real Estate

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June 25, 2013 Pros and Cons of Real Estate Investments