Real Estate Characteristics
Real estate investments differ from other assets classes, like stocks and bonds, and can complicate measurement and performance assessment. This explains why real estate is often categorised as an alternative investment class. On this page, we discuss at least eight real estate characteristics that investors should be aware of.
The first aspect is the heterogeneity among real estate investments. Bonds from a particular issue are alike, as are stocks of a specific company. However, no two properties are exactly the same because of location, size, age, construction materials, tenants, and lease terms.
High unit value
Second, because real estate is indivisible, the unit value is significantly higher than stocks and bonds, which makes it difficult to construct a diversified portfolio
Investors in stocks and bonds are not necessarily involved in the day-to-day management of the companies. Private real estate investment requires active property management by the owner or a property management company. Property management involves maintenance, negotiating leases, and collection of rents. In either case, property management costs must be considered.
High transaction costs
Buying and selling real estate is costly because it involves appraisals, lawyers, brokers, and construction personnel.
Depreciation and desirability
Buildings wear out over time. Also, buildings may become less desirable because of location, design, or obsolescence.
Cost and availability of debt capital
Because of the high costs to acquire and develop real estate, property values are impacted by the level of interest rates and availability of debt capital. Real estate values are usually lower when interest rates are high and debt capital is scarce.
Lack of liquidity
Real estate is illiquid. It takes time to market and complete the sale of a property.
Difficulty in determining price
Stocks and bonds of public firms usually trade in active markets. However, because of heterogeneity and low transaction volume, appraisals are usually necessary to assess real estate values. Even then, appraised values are often based on similar, not identical, properties. The combination of limited market participants and lack of knowledge of the local markets makes it difficult for an outsider to value property. As a result, the market is less efficient. However, investors with superior information and skill may have an advantage in exploiting the market inefficiencies.
We discussed eight real estate characteristics that need to be considered before investing in real estate. The market for REITs has expanded to overcome many of the problems involved with direct investment. Shares of a REIT are actively traded and are more likely to reflect market value.