07.02.2023
Lack of financial literacy can lead people to consider investing in real estate. This is a provocative statement to say the least, so let me explain.
When considering your finances, there are three aspects: how much you earn and the stability of these income streams, your expenses and how to control them; what steps you are taking to plan for future expenses, including your pension.
The younger you are, the more you should invest in yourself, i.e. in education, training, networking, etc. As you get older, you should start saving for retirement and basic expenses, such as buying a car, house, etc.
As you approach retirement age, it’s important to have access to your investments to support your lifestyle and mitigate future losses as you have less time to recover.
Where are investments in direct real estate accounted for? Real estate is illiquid, has high management and operating costs, and if you are going to use credit to finance its purchase, carries the risk of turbulence in the credit markets, i.e. fluctuations in interest rates.
As such, it is not suitable for seniors approaching retirement age or for those just starting their careers who need to channel their money, time and focus on learning and networking (which also means maintaining flexibility as to where they live).
People aged 35 to 45 (or even 30 to 55) should only consider investing in real estate if they make the most of the tax credits provided by the government to build up their pensions, have significant savings in international stocks and bonds, and a fund “for a rainy day”, which corresponds to expenses for 6-12 months.
Given the above, they may consider real estate as an investment option, provided that this investment does not exceed 10-15% of the value of their total portfolio (this ratio is used by pension funds, reserve funds, etc.). But what type of property to choose? It definitely should not be a one- or two-room apartment!
Investing in real estate through an exchange-traded fund (ETF) provides the owner with liquidity, diversification, and less time to manage their investment.
An ETF is a type of investment fund that is traded on stock exchanges as individual shares. He owns a number of properties such as residential buildings, offices, malls, etc., which are professionally managed and can be bought or sold through a brokerage account.
Liquidity
At what point does a liquidity problem become a solvency problem? The problem of liquidity when investing in real estate is related to the difficulty of converting assets into cash quickly and without a significant discount.
For example, if an investor needs to sell a property quickly, but the real estate market is slow, they may have to sell it at a lower price than they expected. The lack of liquid assets can make it difficult for an investor to meet its short-term financial obligations, such as paying bills or making loan payments.
On the other hand, the solvency problem refers to an investor’s inability to meet their long-term financial obligations, such as debt repayment or retirement funding.
For example, if an investor took out a mortgage to buy a property and the value of the property drops significantly, the investor may owe more on the mortgage than the property is worth. In this case, the investor may have difficulty selling the property and paying off the mortgage, and may eventually face the risk of default or foreclosure.
What about your ability to choose a “winner” through your connections and deep understanding?
In 2008, Warren Buffett made a $1 million bet with top hedge fund investors on Wall Street. He bet that in 10 years a simple index tracking fund would outperform the best hedge funds. The results were surprising, as Buffett’s simple equity fund returned an average of 7.1%, while the hedge fund portfolio returned only 2.2% after commissions. Buffett won the bet and donated the winnings to a non-profit organization.
He advised investors large and small alike to stick with low-cost index funds, saying that when Wall Street manages trillions of dollars by charging high fees, it’s usually the managers who make the profits.
Standard & Poor’s tracked a list of active managers and found that 84% of them were ineffective after 5 years and 90% after 10 years. But large fees are still deductible despite bad results.
Direct investment in real estate is great! You can see and “touch” your investments, get a loan to finance them, earn rental income, and then sell them when prices are high. At the same time, it limits your flexibility, is expensive to manage, and is heavily taxed.
