Should You Invest in Real Estate?

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Real estate is probably the most popular investment vehicle. Many people who don't think of themselves as investors and generally don't think about finance and wealth building will still invest in a home and have an opinion about the real estate market.

The general story we hear about housing is something like this:

"Buying a home is always a good investment. Prices always go up."

You could be excused for thinking that real estate is the best investment ever, if you just listen to the general chatter in our culture.

But this has more to do with the fact that real estate is the most socially acceptable investment in our culture, than anything else.

Let's examine a few things that are usually left out of the discussion, to gain a clearer picture of this investment vehicle.

Real Estate is Not an Exception

It's an investment vehicle like any other investment vehicle and, therefore, the same rules apply.

It is true that real estate is a historically well-performing asset. It's not the only asset class that has done well historically. And more importantly: past performance does not indicate future returns.

If real estate is no different from other investments, the first question we need to ask is:

Where Does The Money Come From?

If I'm buying an asset and in the future I'm going to get a lot more money out of it...

...where is that extra money coming from?

First, let's think about what makes a house valuable in the first place:

  • Utility: you can live in it, it's connected to water, electricity, etc. It provides shelter.
  • Scarcity: a home takes up part of a finite resource, which is the land it is built on. Land, especially located in a desirable place, is scarce and this scarcity conveys value.
  • Number go up: most home buyers believe the price will go up and the next buyer (at some point in the future) will pay more. In this sense, there's an element of speculative investing at play.

With that said, let's think about value accrual. What is it that makes the value of a home increase over time?

  • Improved location: in a growing city, what was once a house on the outskirts can become a house in the middle of a new, bustling center.
  • Increased demand: similar to the point above, if a city is growing, there will probably be times of greater demand for real estate than new supply of real estate can be built.

But it's not all rosy. What's often left out of the conversation is the fact that a home can also lose value over time and that's it's not free to own or keep a house.

If we take into consideration runnings costs, costs of upkeep and renovation and property taxes, sales taxes and other forms of taxation that may apply, the numbers can look a lot less favorable.

The main takeaway here is that value accrual depends on many factors. It doesn't happen automatically and it's not guaranteed.

My "Controversial" Takes on Real Estate

  • As an asset class, it's not a magical exception to all other asset classes.
  • Your first house is not a great investment, because when you sell it, you'll have to buy a new home to live in.
  • Past results do not indicate future returns.

Note: I'm not saying real estate is a bad investment. It's just an investment like any other and I recommend you do your due dilligence.

REIT — Real Estate Investment Trusts

If you want to buy real estate as a real investment vehicle, it's good to know about REITs. A problem with real estate is that you generally have to have a large sum of money to enter this investing game. You need at least enough for a down payment on one piece of property.

REITs solve that problem. You can buy and sell shares in a REIT like you buy and sell stocks. The REIT collects the funds from all investors, puts the into real estate projects and the profits are distributed back to investors.

Note: Real Estate Investment Trust is what this kind of vehicle is called in the United States. In other countries, similar investment vehicles are likely available under different names.

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