Property, in the form of real estate, a piece of land, or an apartment or house, is considered to be fairly good investment option. Simple investors feel happy and contended when they invest their money in a property and expect it to give them grand returns. They dream that their net worth will shoot up with an appreciation in the price of the property.
All this is true? Yes and no. It may surprise readers to read the ‘no’ in the answer provided.
Too much of anything is good for nothing. Do you invest most of your money in real estate? Please read on to understand why you should not invest everything in real estate.
Liquidity Aspect of your Property Investment:
Illiquidity of the Property:
While it is true that increase in the property valuation does increase the Asset value in the hands of the holder the key issue of liquidity is missing. Investors often are led to believe that they have very good value in their hands through their property, but what is often not realized is that the value is true only when you have it in your hands and not tied up elsewhere.
When emergency knocks at your door…:
Property value more often than not, is tied up with it and is not in its liquid form, which means exiting from a property investment is way more difficult than any other investment option. Money in its liquid form is best at the time of an emergency when cash is required to tide over a crisis. Imagine a situation when you or one of your loved ones is in need of emergency medical treatment, or may be your son or daughter has cracked a difficult entrance examination and has been selected to join a foreign university, money in its liquid form is what you need.
Trying to arrange for such big amounts at a short notice is well neigh impossible if your entire money is tied up in real estate investments. Worst come worst it could mean the end of a life or an opportunity.
Illiquidity as a Risk:
Asset illiquidity (or lack of liquidity) is an important investment risk and has been the subject of academic research. However, the majority of efforts are directed towards probing the illiquidity of securities, such as stocks and bonds, since they are commonly perceived as highly liquid assets and traded in relatively efficient public markets. However, the “real” illiquid assets, consisting of real estate among others but it has not merited much attention which it deserves. Lack of liquidity in assets is an important source of investment risk.
Price discovery in Real Estate:
Difficulties in buying and selling an asset are often associated with its inherent illiquid nature, by investors. However the extent of such illiquidity is never easy to measure. Trading in real estate is usually a lengthy process and can take weeks, months, even years. Immediate sale of real estate is in most cases next to impossible even for the most cash-strapped owners, and a quick sale usually results in significant discount in price as compared to the property’s fair value. While the high discount may reflect the degree of desperation of the seller, it is not the proper yardstick to measure the trading strategy of sellers who are not constrained by circumstances and can take the time necessary under given market conditions to search until a favorable offer arrives.
It may also be relevant to state here that a house that takes longer to sell than others can be said to be less liquid. However, since the selling time is also linked to the price at which it was sold, it may not necessarily follow that a quicker sale signifies greater liquidity; on the contrary it could be that the price was set too low.
The debt aspect of home loans is also a recurring draw on the investor’s present and future earnings. Take the example where an investor has bought a house for investment purpose and is paying substantial EMI’s on it, now he requires to sell-off the property but is stuck because the market is not conducive. In such cases the investors could face a lot of hardships as a result of this market condition.
Expenses and Legal Aspects
It also needs to be remembered that a real-estate property comes with a lot of in built expenses like taxes, periodic repairs etc. There are also the legal aspects associated with a property. Any modification to the property which is not approved by the relevant authority like the municipality or corporation board could make one liable to pay penalty and in extreme cases the unauthorized part of the construction would be deemed illegal and pulled down.
Some more Points:
Once we invest in a property, we are sentimentally attached to it. We won’t sell it to meet the financial goals of the family.
The major gain in these investments will be realized only when you sell. The returns we get in the form of rent are less than 3% of the cost of investment.
Real Estate need to be part of everyone’s portfolio but one need not invest everything in real estate.
The author is Ramalingam.K an MBA (Finance) and certified financial planner. He is the Director & Chief Financial Planner of holistic investment planners (www.holisticinvestment.in) a firm that offers Financial Planning and Wealth Management. He Can be reached at firstname.lastname@example.org