Whether it’s the high risks of a crypto option or the illiquidity of real estate, there will always be some aspects of a given investment that hold us back. That’s why it’s important to see the bigger picture when you’re approaching investment.
Every type of investment has its disadvantages. But at the end of the day, the best investment is the one whose benefits far outweigh its drawbacks.
How do the benefits of real estate investment compare to their drawbacks? The illiquidity of real estate is often regarded as a sticking point—though this isn’t always the case.
Let’s look into what illiquidity is and the other benefits of real estate investment that make it one of the most secure places to invest your money.
What is Illiquidity?
Liquidity and illiquidity are metrics that describe the ease with which a financial asset can be liquified—turned into liquid capital.
Stocks and bonds, for example, are highly liquid assets. You can buy a stock and sell it with high relative ease. Your asset, the stock, can be turned back into liquid capital in a very short amount of time; day traders buy and sell stocks sometimes within the span of mere hours.
Real estate, on the other hand, is an illiquid investment. It takes much longer to turn your asset, your property, back into liquid capital.
For one, you need to go through the process of selling your property which can take a long time.
That being said, the real estate market has been hot. Last year, the average home sold within 25 days of being put on the market. Homes are going quickly because the real estate market is currently highly competitive.
Still, just because these are ideal conditions for real estate doesn’t mean that they are that much more liquid. After all, even after closing, it still takes around 30 to 45 days to receive payment.
Are There Advantages to Illiquidity?
Illiquidity is a drawback at times due to the slower extraction of your capital from your asset.
When your finances are fraught and you need the funds tied up in your real estate assets, the protracted process of liquifying your property may take more time than you have.
However, if your finances are secure, the illiquidity of real estate becomes a minor drawback.
Furthermore, the illiquidity of the real estate market can be advantageous to long-term investors. Because it takes longer to liquify real estate assets, the real estate market becomes a more safe and secure place to invest money because capital is more contained.
Things move slower in real estate. Financial stability is baked into the market, meaning your assets are better protected from the volatility that characterizes high liquid markets like the stock market.
That can make less liquid assets a hidden benefit of real estate at times.
Benefits of Real Estate Investment
- Low correlation to the stock market
- Allows you to diversify your investment portfolio
- Real estate is a hedge against inflation
- Real estate is highly appreciable
- Tax breaks for real estate ownership
- Depreciation makes property ownership lucrative
- Real estate investments have high cash flow
So, one of the standout disadvantages to real estate investment—illiquidity—can turn into a significant advantage: stability.
But there’s plenty about real estate that makes it a worthwhile asset for investors. Let’s look into other benefits that make real estate investment a smart choice.
Low Correlation to the Stock Market
One of the reasons real estate is safe is that it has a low correlation to the stock market.
Real estate is a fairly insulated market, making it better protected from external market trends.
Correlation is a metric that describes how an investment’s performance is determined by outside performance. For example, if you invest in real estate, how much will waning performances from investments outside the real estate market affect your investment?
The publicly traded securities in the US stock market tend to have high correlations. As corporations merge and fewer publicly traded companies appear on the market, the net correlation between stocks increases.
On the one hand, this can be a good thing. A rising tide raises all boats, so when the economy is on the rise, most stocks could benefit from a high-performing exchange.
But as any investor knows, that isn’t always the case.
High correlation can add extreme risk to investments, increasing the likelihood of suffering from outside factors—a dip in the stock market, for example.
An asset’s lower correlation makes it a safer investment as it is insulated from general market trends that would otherwise negatively affect its value.
Allows You to Diversify Your Investment Portfolio
Diversification is a foundational principle in effective investing and net worth growth.
A portfolio of assets with high correlation is like putting all your eggs in one basket. Because your portfolio is so connected, you increase the likelihood of even one downturn in the market affecting all your assets.
Real estate introduces diversity into your portfolio by virtue of its low correlation.
To start, investing in real estate is lucrative. But when you have the added benefit of protecting your portfolio with a diversified account, the advantages of real estate asset allocation become an essential part of a successful investment strategy.
Recent downturns in the market have led speculators to become bearish about stocks. The economy as a whole is bending towards a more volatile state.
Current stock market trends are why it’s worth looking into low correlation real estate investments.
Real Estate is a Hedge Against Inflation
Inflation describes the progressive decline of purchasing power for your dollar. This translates into higher prices for goods and services.
In all likelihood, you’re familiar with this economic phenomenon firsthand—we’re currently seeing inflation on the rise both in the US and across the world. The rate at which inflation has increased in the past year, 8.5%, is the highest since 1981.
Inflation is on the rise, which is bad news for your savings.
The effects of inflation extend to higher prices at the grocery store or the pump. Over time, inflation weakens the value of your savings.
If inflation rises at a rate that exceeds the appreciation rate of the interest on your savings account, you are losing money. The value of your savings decreases the higher inflation gets, all the more reason to find ways to protect yourself from rising inflation.
Real estate investment provides you with a hedge against rising inflation.
Inflationary increases affect all sectors, from grocery store prices to rent. Because the effects of inflation drive up rent prices as well, real estate assets retain their income rates. If anything, returns are higher because the rising costs, in turn, increase the income earned by rental properties.
Demand for real estate has a positive relationship with GDP growth, allowing real estate assets to overcome the detrimental effects of inflation.
Real Estate is Highly Appreciable
If there’s one benefit that offsets the illiquidity of real estate, it’s that property is extremely likely to appreciate over time.
Appreciation describes the increase in value of an asset over time. Since 1965, the average prices of homes sold have risen in the United States almost every year.
Property is almost always in demand, and that demand is rarely ever outpaced by supply. Houses can’t be built fast enough to meet rising demand. As a result, the prices of property tend to increase consistently.
When the population increases and prices rise, property value only increases. Real estate investment is less about knowing the right time to get in but rather about acquiring enough capital to get in as early as possible.
It’s virtually guaranteed real estate assets will produce a higher return over time because of their high appreciation.
Tax Breaks For Real Estate Ownership
Real estate ownership is expensive. Many tax breaks help investors save money on their property assets when they file, encouraging property ownership.
Beyond the money put down on the house, the costs of maintaining and managing the property, plus general ownership, cause expenses to add up. The high cost of property ownership comes with benefits—tax breaks.
You can write off everything from property taxes to maintenance fees, insurance payments, and mortgage payments. Because of all the write-offs real estate investors can make, rental properties can be a smart financial move in the long term, offsetting illiquidity.
Depreciation Makes Property Ownership Lucrative
Real estate depreciation is how the costs of purchasing and maintaining a rental property can be deducted from your taxes.
From the moment that a property is available for rent, you can account for the expense that goes into maintaining the property’s livability.
Depreciation is calculated using three factors: the basis of the property, the recovery period, and the chosen depreciation method.
The basis of the property is the amount of money paid to acquire the property. Included in the basis are the additional expenses that go with acquiring the property: legal fees, closing costs, back taxes, etc.
When you’ve established the basis of the property, you can find the difference between the land’s value from the building itself. As you’re only maintaining the livability of the building itself, the land is not considered a factor when calculating depreciation.
By establishing the difference between the land and the building, you know the basis of the building itself. That’s the number that determines your depreciation.
Here you can make adjustments based on improvements made to the house and other expenses that factor into getting the property available for rent.
The final number you get from these adjustments determines your depreciation and the amount you can deduct from your taxes.
Real Estate Investments Have High Cash Flow
While real estate is illiquid, it has a high cash flow to make up for it.
Cash flow is a measure of the money coming in and out of an asset. In the case of real estate assets, like rental properties, cash flow is high because they are income earners due to rent paid.
A property’s cash flow is the total rental subtracted by ownership expenses: mortgage, property taxes, etc.
The more equity you have in the property, the higher the cash flow. Paying down the mortgage costs every month increases the cash flow. The longer you invest in a property, the higher the return gets over time.
Residential, commercial, and even industrial real estate can provide you with reliable sources of high cash flow investments, especially in the long term.
Gain All The Benefits of Real Estate Investment With Christina
We’ve seen the benefits of investing in real estate ourselves in our over four decades in real estate investment.
We’ve found our niche for real estate within the Westside region of Los Angeles. Here, ultra-prime assets in neighborhoods like Beverly Hills, Santa Monica, Malibu, and others have shown us hands-on how to get all the benefits of real estate investment.
If you’re interested in investing with our firm, reach out to Christina today.
Sources:
S&P 500 Closes Just Above Bear Market Threshold | New York Times
What Is Inflation? | Investopedia
U.S. inflation has jumped 8.5% in past year, highest since 1981 | LA Times
Average Sales Prices of Houses Sold for the United States | Economic Research