What is Real Estate?
Before going into real estate stocks, let us first understand the core basics of Real Estate. In simple terms, Real Estate is the property in the form of land or building. The owner gets the rights of the property above the land and below the land (underground) as well. The term real estate means real (physical) property. Some say it’s from a Latin word rex, which means “royal.”
How is real property different from personal property?
Real estate is a tangible asset. It includes land and buildings, along with the rights to make use of that land. The owners of the land can rent or lease their land or building to anyone. This gives the renters and leaseholders some rights to the land. However, these rights are not considered as real estate.
There is another type of property called Personal property. It is a misconception among the people that, personal property and real property mean the same. However, they’re different. Personal property includes assets like investments, furniture and fixtures. It is a combination of both tangible and non-tangible asset. Here, the renters and leaseholders may consider these assets as personal property, only when they buy and install the asset with the owner’s permission.
Types of Real Estate
There are four types of real estate, namely, residential real estate, commercial real estate, industrial real estate, and land. Let us understand each one of them in detail.
- Residential real estate
As is it evident from the name, residential real estate includes both new and resale residential homes. The list includes condominiums, townhouses, duplexes, triple-decker, quadplexes, vacation homes, etc.
- Commercial real estate
This is a massively growing real estate sector. Commercial real estate comprises shopping malls, hotels, offices, colleges & hospitals. Technically, apartment buildings are considered as a commercial building, even though they are used for residential purpose. The reason being they are constructed to generate income from it.
- Industrial real estate
This real estate includes buildings used for manufacturing and warehouses. These buildings are primarily used for research, production, and supply of goods. And these goods are stored in a warehouse.
This land can either be vacant or employed for farming activities.
Real Estate sector in the stock market
The real estate sector comprises of companies which are involved in the field of real estate. That is, they are involved in the construction of commercial and industrial buildings. Usually, these are huge real estate companies, which is the reason they are listed on the stock market. This sector is unique because the factors that affect the stock prices are different from other sectors. Let us discuss some of the pros and cons of investing in the real estate sector.
Investing in the Real Estate sector
As discussed, investing in this sector is different from investments in other sectors. The real estate sector is significantly dependent on the surroundings and geographical areas where the companies have constructed their buildings. Therefore, the location of the lands and buildings is a significant factor that should be considered before investing.
These companies are primarily affected by local factors, such as the area’s employment rate, the local economy, transportation facilities, municipal services, and property taxes. The stock prices are affected only for severe national recessions. This is what makes this sector different from the rest.
Also, there are two ways to invest in real estate. People can invest directly by buying the land or building, or indirectly, by buying the publicly traded shares of real estate investment trusts (REITs), or mortgage-backed securities (MBS). These indirect investments provide less control and fewer returns compared to direct investment but provide more liquid than physical real estate.
Which is better, direct investment or indirect investment?
Be it investing directly or indirectly; there are pros and cons to it. Making the right investment choice is vital. So, let’s discuss some of the advantages and disadvantages of investing directly and indirectly in the real estate sector.
Advantages of direct investment over indirect investment
- Simple and Easy to understand
If you do not have any experience in the stock market, it becomes difficult to understand it movement. There is a lot of prerequisite knowledge that must be understood before making an investment choice. But, in the case of direct real estate investment, there aren’t any complicated factors that must be considered before investing.
- Investment under your control
If you buy shares of a real estate company, the returns on the stock entirely depend on the company’s performance. So, you don’t have control over your investment.
On the other hand, direct real estate investment provides direct control to your investment. Though you do not have control over demographic and economic changes, you do have more control to it than in a stock.
- Can be financed and leverage
No doubt, you can purchase a real estate stock using debt, but this could be risky because financing is not quite known for purchasing hard assets. But, direct real estate investment, on the other hand, is usually bought with debt and is pretty safe as well.
Disadvantages of direct investment over indirect investment
- Higher transaction cost
Stocks typically have a minimal transaction cost, which barely affects their profits. In contrast, for purchasing a physical real estate, the transaction cost is significantly high. This can affect profits considerably.
- Low liquidity
Real estate stocks are highly liquid, which means that you can buy and sell within a few seconds. But, when it comes to direct investments, liquidity is a big issue. An investor has to wait for months, or even years, to make money out of the investment.
Real Estate ETFs
Some of the top performing real estate Exchange-traded funds are:
- Vanguard Mortgage-Backed Securities ETF
- iShares Barclays MBS Bond ETF
- SPDR Bloomberg Barclays Capital Mortgage Backed Bond ETF
Investing in individual stocks always has risk involved with it. However, making the portfolio diversified can help reduce the risk by a good percentage. Therefore, it is recommended to invest in the above ETFs rather than in one specific stock, because, it diversifies one’s portfolio and also reduces risk along the way.