Although many of us inwardly feel that real estate is a good investment, it is worth exploring in more detail what lies behind that.
Real estate as an investment vehicle has matured considerably over the past three decades. As an asset class it has acquired a much more institutional character, (i.e.) many companies, such as pension funds and insurance companies, have decided to invest in it. For large investors it has in many cases become a third pillar after stocks and bonds.
Why real estate and why right now?
There are several reasons why real estate is often considered a good investment by institutional and experienced investors.
Returns
Real estate brings two sources of return:
Income return
The first return flows from rental income, which the tenant (or guest, if it is a hotel or holiday property) pays to the owner. The level of rent is governed by the job market, which is closely tied to the economy. A stronger economy supports greater growth and movement of jobs (often including population growth) and higher wages. A good example is Prague, where economic growth combined with population growth and a low number of vacancies pushes up salaries and disposable incomes. In such a situation, individuals are able to pay more for rent.
One of the specific draws of residential or holiday properties is that rental agreements are often short (a maximum of one year, or really just days or weeks for guests staying in holiday rentals). This means that owners can often quickly and regularly adjust the required level of rent in order to keep pace with inflation and market conditions.
Returns from capital appreciation
The second element of the total return is growth in the market price (return from appreciation of the capital value), where the value of the asset increases over time. This tends to be more strongly connected with developments in the capital markets (including interest rates and inflation). In times of economic growth, inflation can increase the replacement costs of properties, and therefore the value of properties will increase over time, especially when interest rates are lower.
Risk
Real estate differs from stocks and bonds in its risk and return characteristics. Usually real estate shows lower risk and lower return than stocks, and higher risk and higher return than government bonds. But even within a single category, such as the fairly broadly defined real estate, there are various risk-and-return ratios. For example, development projects represent higher risk and a higher expected return is expected of them. Whereas prime properties in the best locations fall lower on the risk curve and a lower expected return is expected of them.
Protection against inflation
Investing in real estate is an excellent means of protecting money against inflation for several reasons. Above all, real estate tends to increase in value during inflation, which means that its price rises along with rising prices in the economy. This allows investors to keep pace with inflation and ensure that their investment retains its value. In addition, if you invest in real estate for the purpose of renting it out, you can increase the rent in line with inflation, which means that rental income grows along with rising prices and helps to offset the negative impacts of inflation on the value of money.
Residential properties and holiday rentals
There are a number of reasons why residential and holiday rentals are an attractive opportunity for investing.
As far as residential markets are concerned, the build-to-rent (BTR) and private rented sector (PRS) segments are becoming an increasingly sought-after asset class in Europe. One of the factors that have recently contributed to this is the fact that both the office and the retail sector have fallen out of favour with many investors over the past two years. The office segment as a result of the impacts of working from home, and the physical retail market was affected by the rising trend of online shopping.
Global tourism markets are increasingly opening up and tourist numbers are rising after Covid and a slow return to full capacity, and this helps to increase demand for holiday rentals. Holiday rentals as a broader industry have also seen enormous investment in recent years, particularly in technology and visibility, which has helped to create a more mature and comprehensible market that is important for all investors, but especially for larger institutional investors, who need to thoroughly analyse the risks, returns and opportunities in this industry.
All the forces described above affect in particular the demand side of the equation. The level of rents and capital values is ultimately the result of the interaction of supply and demand. As far as supply is concerned, in many areas in Europe, whether it is specific urban areas or tourist resorts, the supply of development projects is limited, for example due to demanding planning regulations. Thus a limited supply unable to cover potential demand is another factor that contributes to the growth of rents and capital value.
Portfolio diversification
Including real estate can be very crucial for the proper diversification of a portfolio. Firstly, real estate usually has a low correlation with other market classes, such as stocks or bonds. This means that the value of real estate need not fall in the same way as the value of other investments at a time when markets fluctuate. Thanks to this low correlation, investing in real estate can reduce the overall risk of a portfolio and help to balance out fluctuations on the markets. Moreover, investing in real estate can provide regular rental income, which is often stable and independent of market conditions. This income from real estate can serve as a stable source of cash flow and strengthen the overall performance of the portfolio. Diversification into real estate can thus bring investors not only potential capital appreciation, but also stable income and reduced risk. It does not matter when you invest; the rules for diversification apply at all times, and therefore there is no better time than the present to include real estate as an asset class in your portfolio.
Real estate and barriers
Investing in real estate can be associated with several barriers that may limit investors' access and participation. Some of these barriers include:
- Financial requirements - One of the main barriers is the need for sufficient financial capital to purchase property. Real estate usually requires high initial investments, such as the purchase price, a deposit, brokerage fees and maintenance costs. These financial requirements can limit access for smaller investors.
- Market knowledge and risk management - Investing in real estate requires a certain level of market knowledge, including the analysis and understanding of trends and property values in the given location. Managing property also requires the ability to manage risks associated with tenants, maintenance and legal matters.
- Limited liquidity - Real estate is usually a less liquid investment compared to other asset classes, such as stocks or bonds. Selling a property can take longer and require additional effort and costs associated with the sale, such as legal representation and brokerage fees. Limited liquidity can restrict the ability to quickly access funds when needed.
- Regulation and legal matters - Investing in real estate is often accompanied by various legal matters and regulations. These include rent laws, building regulations, consumer protection laws and others. The investor must be familiar with local legal regulations and ensure compliance with all relevant laws and regulations.
- The need for time and maintenance - Investing in real estate requires time and effort for management and maintenance. The investor must be prepared to invest time and resources into managing the property, including finding tenants, carrying out repairs and maintenance, and resolving various matters associated with the property.
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