What Are the Pros and Cons of Property as an Asset Class?
Property as an asset class is one of the most attractive available. The real estate asset class combines the potential for capital appreciation with consistent cashflow through the collection of rents. On the other hand, investors who buy property have to contend with real estate's relative illiquidity as well as the challenges inherent in managing an asset class, which can have more in common with running a business than with other passive investment vehicles.
One of the key advantages of property as an asset class is that it offers the potential for significant cashflow. Bonds typically offer cashflow, albeit at low rates relative to their risk level, and dividend-bearing stocks typically derive most of their growth potential from price appreciation as opposed to dividend payments. Investment real estate, though, tends to provide most of its return in the form of net operating income (NOI). As long as the property is operating properly, its owner should enjoy regular cash income, even after paying both operating expenses and debt service.
Investors in real property benefit from the ability to use leverage. Real estate financing might be available at levels as high as 80 percent of the purchase price, so property owners can use debt to take advantage of growing values and of growing NOIs and to multiply their positive effects. Other asset classes — such as stocks — that offer the opportunity to use leverage are typically subject to short-term calls. Real estate financing lasts for long, fixed periods of time, making it easier for investors to weather the market's ups and downs.
Property as an asset class also offers the potential for appreciation. Although real estate can lose value, it usually offers long-term appreciation at or above the rate of inflation. The appreciation potential comes from the fact that real estate is a tangible asset that is scarce, because no additional land is being created.
Real estate's tangible nature also ties to one of its major drawbacks — it requires management. Although it is possible to take ownership of property within a passive structure, most real estate assets need to have someone perform tasks such as collecting rents, paying bills, taking care of buildings and leasing out vacant spaces. This makes property much more difficult to own than passive assets such as stocks and bonds.
Stocks, bonds and other paper asset classes have an additional benefit over property investments because they are liquid. Most paper investments can be quickly traded at very little cost. Property as an asset class, though, is illiquid. Selling property for a fair market price typically takes weeks or months and involves transaction fees that might range from 1 percent to 10 percent. For investors who need to be able to quickly convert their assets into cash, real estate typically is not a good choice.
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