Like many other kinds of investments, there are pros and cons of investing in real estate and one needs to weigh all the avenues of what will work best for each individual’s financial situation. The following are some advantages and disadvantages that should be considered before making the decision to purchase property as a primary investment.
- Rate of return. Historically, real estate has produced an above-average rate of return for owner-investors, compared with other types of investments.
- Tax advantages. Real estate investments receive certain tax benefits.
- Hedge against inflation. Usually, real estate prices will increase (property appreciation) at a faster pace than inflation. If a parcel of property is acquired at market value or less, an owner will normally find that the sale price increases faster than other prices.
- Leverage. Real estate is typically highly leveraged. An investor can usually borrow up to 75% of the appraised value and the goal of leveraging is to increase one’s yield (return) on equity (investor’s own capital) by using borrowed funds.
- Equity buildup. As a property appreciates in value and the mortgage debt is reduced, the investor’s equity grows.
- Illiquidity. Real estate is not considered a liquid investment over the short term.
- Market is local in nature. The real estate market is more local in nature compared with other investments. An investor is usually interested in a particular property type and geographic area.
- Need for expert help. Many expenses are associated with investing in real estate, including the need for property managers, financial consultants, and legal experts.
- Need for active management. Properties must be cared for, rents collected and so forth.
- Risk. An investor must weigh the chance of losing invested capital. There is a higher degree of risk in real estate investments than in other kinds, due to possible tenant turnover, increasing property taxes, and increased costs associated with overall operations.
Investors should have a target rate of return in mind when they invest in real estate. Factors out of control of an investor, such as inflation, rising interest rates, and an economic downturn in general create uncertainty that the actual rate of return will provide what the investor needs to be profitable. Therefore, a decision to purchase real estate as an investment should be thoroughly researched before moving forward.