Real estate. If there’s one investment type that everyone’s familiar with, it’s this. We literally spend our lives surrounded by it. In most places, you can’t go more than a few steps without running into a real estate agency or a property for sale. But as omnipresent as it is, fewer investment vehicles are as misunderstood as real estate. We want to explore why that’s the case and clear up some of the mystery.
Real estate is all around us. We live in houses or apartments. We work in office buildings and stores. When we eat at restaurants or go shopping, we’re doing so in someone’s property.
It’s what economists call a scarce resource. There is only so much physical space available in any given place. If there’s a lot of demand for property in that space, then whoever owns the space stands to benefit handsomely.
Perhaps more importantly, we can touch real estate. This sensory connection allows us to assign value to it, fueling our fascination. And as any renter will tell you, when we see our money going to someone else for rent each month, we wonder if we’re on the right side of that transaction.
Put together, these factors attract investors of all ages and experience. Given this natural attraction, we should ask: is real estate a ‘good’ investment? Further, should people living abroad invest in properties?
Before we can answer these questions, we need to lay some groundwork to build up our knowledge.
Different types of real estate and their uses
Real estate generally falls into three different categories:
Residential real estate are places where people live. Usually, people purchase a house or an apartment to live in as their primary residence.
Buying multiple residential properties are also popular with investors, for reasons we’ll explore below.
Commercial real estate is any property used for commercial purposes. Office buildings, gas stations, restaurants, supermarkets, and hotels are all forms of commercial real estate.
Investing in commercial real estate requires a considerably substantial investment — think millions of euros at the minimum. Therefore, most individual investors cannot access it, at least not directly.
We also include industrial real estate with commercial properties. While there are some differences between commercial and industrial real estate, they share more similarities with each other than with residential real estate.
Land investors buy undeveloped property in hopes that it and the surrounding area will become a target for developers at a future date. Investing in land requires patience. While the goal is to sell it to a developer to convert the land into commercial or residential real estate, it can take years, if not decades, for a buyer to come along and purchase the land.
How real estate generates returns
Like any investment, real estate (should) create returns. The two ways it does so are:
- Income generation
- Capital appreciation
Income generation is just a fancy way of saying “rent.” In this scenario, the real estate investor owns some property — like an apartment — and rents it out. The rent generates additional income for the investor, which she can use for whatever she likes.
We can think of rent as a dividend payment on a stock, where there’s a steady stream of income coming from an underlying investment. We can even calculate the rent as a percentage of the property value, much like we calculate the earnings per share for stocks.
Of course, stocks and real estate are radically different investments, but from an income generation point of view, they do have some similarities. However, it’s a useful metric for investors when evaluating real estate investing for income purposes.
Capital appreciation is a bit different. Instead of expecting a steady income flow, capital appreciation investors buy real estate speculating that its future value will be higher than it is currently. At the minimum, these investors want the property’s value to keep up with inflation.
We see a lot of ultra-wealthy individuals from developing countries use real estate for capital appreciation. In places like London, New York, Vancouver, and even Lisbon, uber-rich people will buy property as a way to (somewhat) safely park their funds offshore. There’s a lot to be said about the negative impacts on rent and affordability, but if you were looking for a real-life example of capital appreciation, here is where you would find it.
It’s important to remember that these goals aren’t mutually exclusive. A rental property can both generate income and increase in value. A lot of residential real estate investors look at both of these metrics since it gives them a better idea of the actual value of their investment.
Another hybrid strategy is investing in properties in need of renovation. Here, an investor buys a piece of property, refurbishes it, and either sells it for a profit (capital appreciation) or rents it for more than he could’ve before the remodeling (income generation). A lot of investors like this flexibility since it gives them options once the work finishes.
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Real estate demystified
It’s no surprise why real estate investing is so popular. With different possibilities, real estate can help meet the needs of many kinds of investors. Some use real estate to generate income. Other investors use it to store value through capital appreciation and speculation. Others try to do a bit of both.
For people living abroad wanting to invest, understanding this investment type will help us make better decisions. After all, the last thing we want to do is throw our money into some exotic property without knowing why we’re doing it and how we’ll reach our goals. That said, there are factors expat investors need to be aware of.
Varying exchange and inflation rates can create a real loss for an otherwise profitable investment if the owner lives in a different country. Taxes quickly get complicated as investors build global property portfolios. Each city — let alone country — has specific rules for buying and selling real estate. An expat investor can avoid many of these pitfalls by seeking specialist advice.
In our next article on the subject, we’ll explore the pros and cons of property investing. We’ll also look at the different ways investors can access real estate. For now, though, we’ve laid a solid foundation to build our knowledge upon (sorry, not sorry).
Abroaden is a company for expats, digital nomads and other world citizens looking for low-cost and transparent financial advice and investment management.
Note that this article is for information and educational purposes only. It does not constitute financial advice.