Direct and Indirect Real Estate Investment

by | Oct 24, 2022

Direct Real Estate Investment

Direct real estate investment involves buying a stake in a particular asset. This is inclusive of equity and debt investments.

Equity investment involves purchasing stock in a business that controls real estate, such as an office building or apartment building, and debt investing involves capitalizing the loan secured by real estate, such as a plot of land or an existing structure.

Types of Direct Real Estate Investment

1. Venture Capital

This is a direct investment in real estate made in a young company. It provides the company with a specified amount of startup money in exchange for a portion of it without needing a majority stake.

2. Growth Equity

This is a direct investment whereby money is put into a business that is already established and expanding but still needs money to develop.

3. Buyouts

The most advanced direct real estate investment in a company’s lifetime is a buyout. Most of the money used for private equity investments is used for this kind of investment.

Besides, buyouts come in two types, i.e. management and leveraged buyouts. Management buyouts are cases where the present management team buys a company’s assets and takes over the management.

On the other hand, buyouts financed using borrowed money are referred to as leveraged buyouts.

Advantages of Direct Real Estate

  • Greater Tax Benefits

Direct investments allow tax losses to pass through and be utilized to reduce taxable gains. Several tax benefits and deductions are available to real estate investors, saving them money throughout tax season.

Most of the time, the expenses associated with having and maintaining the property are deductible. Why? You can take advantage of years’ worth of deductions to reduce your taxable income by making valuable improvements to the investment property throughout its usage.

  • It Allows for Superior Portfolio Diversification

The risk-adjusted returns of a portfolio should increase as diversification occurs. This suggests that the returns are high depending on the risks they encounter. Therefore, the more the investors go through the trouble, the more they increase their chances of making money for investors.

Still, risk-adjusted returns often show how effectively an investor’s money is being spent. Even though it cannot protect against the loss, diversification is essential for attaining long-term financial goals and lowering risk.

Direct real estate investing can be a preferable option if one desires cash flow because there are tax advantages to offset that income and good potential for profit. It’s great if you like a hands-on approach and want more control over your finances.

Disadvantages of Direct Real Estate

  • Lack of liquidity

Any real estate venture must take liquidity into account. Assets’ liquidity determines whether they will be sold quickly or gradually and whether the price will be lower or higher than the market price.

However, in direct real estate, it is a problem. Lack of liquidity makes investments difficult, especially if one desires immediate cash because it would be challenging to sell tangible assets.

  • Financing

Financing is a crucial factor in real estate investments. The ability of a potential real estate investor to purchase a home, whether for their use or as an investment in rental property, depends on a variety of factors, including prime interest rates, mortgage rates, and another mortgage- or home-related elements.

Having bad credit makes it challenging to get loans. However, it wouldn’t stop someone from buying a house. Almost everyone can obtain home finance if they have a sufficient down payment. In contrast, financing may still be a problem or nearly impossible to get with excellent credit but no cash on hand, restricting the potential of real estate investing.

Indirect Real Estate Investment

Indirect real estate investment involves purchasing shares in a private or a publicly owned company.

The common initial step for these investors involves purchasing shares of publicly-traded or non-traded REITs Real Estate Investment Trusts.

Types of Indirect Real Estate Investment

1. Land Banking Schemes

This real estate investment concept entails buying vast tracts of undeveloped land and selling it for a profit. When using this investing technique, investors predict the future of a region and take advantage of the rising demand for real estate near urban centers by purchasing at low prices and then selling them for a profit.

2. Real Estate Investment Trusts (REITs)

These businesses operate in various real estate sectors and own or finance income-producing properties. To be eligible to become a REIT, the company must satisfy specific criteria. The criteria indicate that the minimum total assets to be invested in real estate is to be precisely 75%.

Advantages of indirect Real Estate Investment

  • Provides Better Liquidity

Liquidity describes your capacity to convert an asset into money. Real estate gives a lower liquidity level in the four investing asset classes: cash, equities, real estate, and bonds.

That means you cannot just turn a rental property into its cash equivalent; you must prepare the property for sale, promote it, receive offers, negotiate the terms of those offers, and then enter escrow and close the deal.

Months could pass during the procedure. Shares of REITs are just as liquid as equities for indirect investments, which can be quickly traded on the open market.

  • Provides Better Diversification

To spread out the risk of investing, diversity in investing refers to the practice of putting your eggs in different baskets. Let’s say you had $100,000 to invest; you might fund the entire amount at once or divide it into ten $10K investments.

This view suggests that diversification through indirect investing is more straightforward. You can quickly invest in several REITs with various investment strategies, covering a wide range of asset classes in several geographical locations, by purchasing shares of REITs.

Many investors who invest directly must allocate a more significant portion of their investable cash to a smaller number of investments, which concentrates on the risk of assets. If one of your investments fails, the portfolio of the investment will be affected by a more significant portion.

Most investors prefer diversification to some extent. To optimize their prospective returns, investors might wish to focus their investments if they have a high-risk tolerance and a long time horizon.

Disadvantages of Indirect Real Estate Investment

  • Higher Taxation in Indirect Real Estate

The dividend is said to be qualified if the capital gains tax rate on a dividend is lower than the income tax rate on a total or ordinary compensation.

But because the rewards from indirect real estate investments are qualified, they are subject to hefty taxes and provide the investor with little financial gain. Increased indirect taxes may result in cost-push inflation and higher inflation expectations.

  • Sensitivity to Interest Rate Fluctuations

Another difficulty with indirect real estate investing is its sensitivity to changes in interest rates. The sharpness of investment determines how it reacts to changes in the external environment. Particularly vulnerable to interest rate changes are bonds and stocks.

The discount rate plays a critical role in determining the potential value of equities. According to the explanation, it is evident that corporate bonds are fixed-income investments. Therefore, when investors buy one, they are essentially buying a portion of the company’s debt.