It is the only type of investment that offers this high degree of leverage. Accordingly, investors can amplify their returns from real estate compared to a share portfolio with the same investment amount.
Disadvantages
The disadvantages of investing in real estate include lack of liquidity, lack of diversification, large capital requirement, time and cost of management, and risk of serviceability.
A property owner requiring funding is unable to sell a doorknob or a hallway to raise the cash needed. The lack of liquidity can be quite costly if investors are forced to sell during a property downturn or due to a deceased estate.
Furthermore, if investors only hold real estate assets, the lack of diversification would compound the lack of liquidity issue.
Also, a significant amount of capital is required to start investing in real estate. Australian house prices have seen remarkable growth of around 7% per annum over the last 30 years, which raises the question of housing affordability today.
The Reserve Bank monitors this trend closely as the Australian household-debt-to-income ratio reached around 185% as of November 2020, of which 76% is housing debt.
Managing an investment property requires time commitment. This can be outsourced to a real estate agent for a fee or managed by the property owners themselves. Either way, there is an added cost (both financially and mentally) of dealing with extended vacancies, bad tenants, and damages.
Finally, there is a long-term risk of serviceability in the event of rising interest rates or loss of salary due to role changes, retrenchment, illness or disability.
Listed property
In contrast, the advantages of investing in listed property include having greater liquidity, better diversification, access to specialist property managers and a wider range of investment options, a lower capital requirement, and receiving a high yield.
By investing in listed property via Australian Real Estate Investment Trusts (A-REITs) or Exchange Traded Funds (ETFs) on the ASX, investors have daily liquidity and can time their investments to buy during market downturns or share-price weakness.
There is also the ability to raise cash within a short timeframe if funding is required by selling a portion of their investment. Investors can hold a well-diversified portfolio with exposures to retail, office, and industrial listed properties, both domestically and globally, which can help reduce the overall investment risk.
Investors are not required to have extensive knowledge of the sector as they can access a wide range of expert managers operating high-quality property assets. During market downturns, economic recessions, or event-specific sell-offs, investors have the ability to switch out of particular sectors that are underperforming and increase their exposure to other sectors that are likely to perform better in a recovering economy.
There are low barriers to entry as investors can start with a small investment and add to it over time. Listed property shares can pay high yields that are generally considered defensive income as it is derived from rent rather than corporate earnings, which may be more volatile.
However, as with all listed investments, the risk of listed property includes market risk, timing risk, rising interest-rate risk, exposure to currency risk if holding global property assets, and the risk of total loss of investment.
Ultimately, depending on your personal circumstances, level of risk aversion and income needs, you may find one investment type to be more appropriate than the other. This will naturally change over time based on your stage of life, so it might be prudent to periodically reassess your financial goals and adjust accordingly.