For investors, real estate represents a particularly appealing combination of stable income and long term growth that fits many investment portfolios. The ease of determining valuations and costs also make calculating the potential rate of return on a property more akin to a bond than a stock. Perhaps the most endearing feature to investors is the concrete nature of real estate. You can inspect it, renovate it and if things go wrong you can move in and live in it. So what then, are the drawbacks to direct investing?
Entry costs – Accessibility is the major limitation for most investors. If an investor uses the traditional rule of thumb limiting a single holding to 10% of your portfolio, the range of investment opportunities narrows dramatically. Even for high net worth investors, the cost of a multi-family building, a commercial structure or an entire development raises the access bar proportionally. Real estate practitioners generally agree as well that investors regularly underestimate normal transaction costs, the cost of upgrades and ongoing maintenance costs associated with a property.
Liquidity – A major investment in a single property breaks the first principle of investing - diversification. Even apart from an extended market downturn, the normal time frames of valuing, listing, and closing a property, can cause significant pressure for an investor unexpectedly requiring cash. Liquidity concerns extend to the cash reserves required for maintaining a property against any unexpected costs, which also creates an opportunity cost for the idle cash better invested elsewhere.
Third-party Management – If you own a rental property, you are subjected to tenant complaints, late payments, home maintenance and city by-law requirements. Given the demands of tenants and bureaucrats, many direct investors will hire a property management company. However, most property managers are reluctant to take on a single property and will normally charge 7-10% of the income, which is approximately equivalent to a 2% management fee on market value.
Investment Strategy – Many direct investors assess properties looking for a “bargain”. Yet, professional managers will attest that real estate can be the ultimate value-trap if particular flaws, community constraints, or changing demographics, aren’t taken into account. It is difficult to exercise the normal due diligence for a particular real estate transaction if an investor has not done the research and acquired the expertise to assess all of the variables involved.
At Northland Wealth Management our team has decades of experience in appraising, buying, managing and underwriting real estate as an investment. We have combined this expertise with our extensive industry network of institutional managers to allow our clients to access best-in-class opportunities from around the world. To learn more about how investing in real estate may benefit your portfolio, one of our Advising Representatives would be pleased to speak with you.