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.
Here are some of the advantages and disadvantages of real estate investments, which the best investors use to their advantage to increase profits.
#1 Real Estate Can Be Easier to Understand
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.
#2 Real Estate Is Improvable
After you buy a stock, you hold it for a period of time and hopefully sell it for a profit. 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.
#3 Real Estate is a Hedge Against Inflation
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.
#4 Real Estate Properties Exist in an Inefficient Market
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.
Real estate investors who do their research, especially with help from industry experts, can find great real estate bargains.
#5 Real Estate Can Be Financed and Leveraged
Of course, you can technically purchase stocks and other assets using debt, but this can be very risky because the financing is not to purchase a hard asset. Real estate, on the other hand, is a market where products are usually bought with debt.
Real estate investments purchased with hard money or a mortgage can be structured in ways that are rather safe and affordable, so that large purchases can be made with a relatively small initial investment. The result is the purchase of a hard asset that appreciates year-over-year, and paying for it primarily with other people’s money.
#6 Real Estate Has Higher Transaction Costs
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.
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.
#7 Real Estate Has Low Liquidity
Many investments are highly liquid, and can be bought and sold for a profit in a fraction of a second, as with high-frequency stock trading. But real estate investments are comparably illiquid, because properties can’t be quickly and easily sold without a substantial loss in value.
Real estate investors must be prepared to own a property for months and years, especially if it will be leased out.
#8 Real Estate Requires Management and Maintenance
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.
#9 Real Estate Markets Have Significant Inefficiencies
As we’ve 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.
#10 Real Estate Creates Liabilities
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.
Like all investments, real estate has advantages and disadvantages.
The best real estate investors leverage both the advantages and disadvantages to increase profits.
If you would like to see how we use the advantages and disadvantages associated with real estate to produce cash flow and profits, you can get started by filling out an Investor Profile or contact us direct.