True accounting of your real estate investments

7 June 2021

A unique asset class

Real estate: possibly the first asset class that ever existed, it is also the most personal – at least for most people. Unlike a bond or a share, you can design your house, you can refurbish your apartment, you can colour, create, change, break and rebuild. In other words, you can use it and personalize it.

To be sure, real estate is a lot more than a property for personal use. It is the backbone of the real economy. Think airports, shipping ports, data centres, warehouses, commercial buildings. And of course the market has evolved its ways of investing in real estate, from dedicated funds to REITS (Real Estate Investment Trusts).

Direct ownership

But when it comes to direct ownership of a property, a lot is often lost in translation. The result is that the investment decision may be based on inaccurate considerations.

Allocation

Firstly, allocation. Because so many of us have grown up thinking property prices can only go up, we are comfortable putting all our money into a property. Actually, sometimes a lot more than that! But as the 2008/2009 crisis showed, and how some people that invested in volatile real estate markets experienced, that decision is a risky one that has to be evaluated carefully. Sometimes, and in some places, prices can go down! And even if they don’t, can it be sold at all?

Liquidity

This brings up the second consideration, liquidity. Buying and selling a property is never easy, nor cheap. Depending on the jurisdiction taxes and fees can be substantial. Not to mention the paperwork and the time involved. And that is when there is a buyer and a seller. It can take months if not years to find either one. Having said that, “house flipping“, the process of purchasing a property with the intent of renovating it and then reselling it for a profit, has become more common in recent years in certain jurisdictions.

Return

Lastly, the return. Who hasn’t heard a friend, an acquaintance (or themselves) saying something like: “I can buy this apartment for 400,000USD, and rent it for 20,000USD: that’s a 5% return per year, not to mention the capital gain if I can sell it in the future for more than I paid for it.” When one accounts for agency fees, maintenance costs, income tax, etc, that 5% can more than half in a heartbeat. And if a tenant leaves, until a new one comes in a lot of those costs keep running without matching revenues.

Short-term rentals? It can be an interesting choice, as many Airbnb hosts can confirm. But do you account (and if so, how?) for the time spent in managing your property on the platform and dealing with guests? You may not have to, but that may well cost you up to 25% of your revenues – eroding even further an elusive expected return that seemed so enticing at first.

Conclusions

Yet, the appeal of a Real Estate investment defies many of its drawbacks. Because it answers a primordial need for shelter, because it’s there and you can live in it if you wish. But careful attention in the assessment and selection of a property can make it a bit less of an emotional investment. And it can save investors from some unwelcome surprises in the future.

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