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Wednesday, September 30, 2020

L1: The First Letter: Pros and Cons of Real Estate Investing

Hi Everyone,

I’m excited to be doing this. I know most of you must be enjoying spending quality time with your families. We’re at a unique time when a virus has disrupted our lives, businesses while also giving us the time to introspect about the future. Due to my day job at Tripvillas – it’s common for people to come to me for advice when they are looking to buy or invest in real estate. These people range from fresh investors who are looking to buy their first home to experienced entrepreneurs who have exited their businesses and are sitting on capital or else very savvy stock market investors now looking to diversify into Real Estate. As this is the first letter, I thought I would start by outlining a few ways in which investing in real estate is very different from any other asset class. To start off with let me share with you a few cons of investing in Real Estate:-

  1. It’s illiquid
  2. It requires a lot of capital.
  3. Returns will rarely exceed 15% per annum.

Having said this, let me share with you a few Pros of real estate investing:-

  1. It is one of the few asset classes where the asset class itself can be the source of capital to acquire the asset.
  2. It tends to be held for long periods of time – usually 15-20 years – thus allowing compounding to work in your favor.
  3. It’s income usually escalates steadily – you can in most cases work in a clause to allow yield to escalate at 6-7% per year – which compounded will catch up with your debt repayments in a few cycles.
  4. Due to its chunky nature, you end up putting larger sums of money at work and so the outcomes tend to be meaningful.
  5. In comparison to businesses in 2020, Real estate tends to have a longer shelf life. With investing in businesses and companies, you have to be very alert and to keep revisiting the business and its prospects. Real Estate being real tends to easily remain lucrative or get even more lucrative for a 50-60 year horizon.
  6. Competition has a silent creep – Given that most of your competitors would have a mortgage – It’s safe to assume prices have to move upwards every year by at least the prevailing mortgage rates for them to recover their cost and so you would benefit from this.

However, I want to highlight a few things to keep in mind when investing in Real Estate that are not obvious and which Real Estate investors would be well served to keep in mind for superior returns.

  • Development brings Returns: A proactive government, an accelerated path to industrialization, wealth creation to entrepreneurship – these are all guaranteed to have a positive impact on real estate prices. As such, it makes sense to pay attention to these things.
  • Avoid getting stuck on a bridge to nowhere: Remember – a roadside shop only has value if there is heavy traffic on the road – It’s most probable that routes between two major economic hubs will see appreciation along with significant traffic growth as these two extremities grow. As such, watch for such opportunities.
  • Somethings are just irreplaceable: The weather, natural beauty, the indigenous mindsets, Art, Culture, History – these are just very hard to replace and so will always have value.

and lastly,

Real Estate is a Capital Gains business – Unlike all other forms of investment where you have to remain focused on the future earnings and then the business gets valued based on a discount to the future earnings, with real estate you must remember that you are investing to exit at a higher capital value – as such all efforts have to go towards this – and really the operating revenue is important but operating costs are not, the team to manage the asset is not and how you manage your costs is not. You will very rarely get a capital value higher than a neighboring property that is not as well managed or which employs a lot more staff etc. You have to treat the business as such as an equity black box – figuring out how you can reduce your maximum equity exposure and making as good a return as possible through the highest possible capital gains.

I hope I have given you some food for thought. Till next week when we will discuss the world of international property investments.

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