Any discussion on real estate is bound to bring passionate debate among individuals and not without reason. After all, parents and grandparents would have primarily accumulated wealth investing in real estate. Importantly, the physical nature of the asset makes it compelling as an investment, compared with equity. Here, we discuss two factors relating to real estate. One, investment in land may be more optimal than investing in properties. And two, investment in Real Estate Investment Trusts (REITs) is not a pure bet on real estate.
Land versus property
Land is scarce. Building is a depreciable asset. Therefore, investing in land appears better than investing in property. Another benefit of investing in land is you can build a house for self-occupation or to generate rental income at retirement if you are unable to sell it for decent gains. Property investments, on the other hand, may not always be optimal. Why?
Low rental yields
Property investments, like equity and bonds, can provide capital appreciation and rental income. The issue is rental yields are low because of high property cost. Achieving capital appreciation depends on the age of the property at the time you sell and the cost at which you bought it. Given the current property prices, it is moot if the investments can generate high capital appreciation the way they did in the past. Also, if you buy apartments in high-rise buildings, your undivided share of land is small. So, the potential for gains depends on the rise in new property prices in the area at the time you sell the property. But old property may not fetch the market rate for a new property. Also, it is moot if returns are likely to be better than that of equity investments, which is more liquid and less lumpy.
Conclusion
Not everyone can buy land or property, given the lumpiness of the investment. The alternative is to buy REITs — listed vehicles that buy commercial complexes to earn lease rentals. REITs must pay at least 90% of their net distributable cash flows to their investors every year. You must be mindful of two factors.
Capital appreciation from REITs may be lower compared with direct investment in land. And, REITs are not a pure bet on real estate. This is because prices of REITs can decline when stock markets crash, even if the real estate market is stable.
(The author offers training programmes for individuals to manage their personal investments)