Real Estate Investment: Individual Real Estate Investment Vehicle - Literature review Example

REAL E INVESTMENT: INDIVIDUAL REAL E INVESTMENT VEHICLE AND PART OF PORTFOLIO INVESTMENT By Location Introduction Manganelli (2014) defines real estate as physical property especially land that has on other improvements on it including buildings, houses, wells, fencing among others, therefore, real estate investment is the interest on property ownership. The real estate investment has been considered for a long time to be a lucrative and viable business though the success depends on the investment approach (Rehring, 2012). When, for instance, an individual buys a home even through mortgage, he or she invests directly in real estate and becomes both the investor and assumes the legal title of the particular property. In this case, the investor enters real business estate using the property as an individual investment vehicle. In some instances, an investor may wish to include other forms of real estate holdings to his or her portfolio thus assumes indirect investment into the real estate (Bouchouicha, & Ftiti, 2012). Alternatively, an individual can invest in a real estate business entity that acts as the owner and the manager of the real estate property. Therefore, it is imperative to identify benefits, challenges, and methods of investments that an individual must be knowledgeable about before owning a property either directly or indirectly (Allen, & Carletti, 2013). Thus, the paper discusses the pros and cons of investing in real estate as an individual investment vehicle as opposed to part of an investment portfolio. Individual real estate investment and investing as part of the investment portfolio Individual property ownership entails purchasing the ownership privately in real estate where a person chooses to manage the property or hires a property manager to operate the property so as to earn money in form of rent from tenants. Individuals have become a common investment vehicle where a person holds the investment on his or her name (Rehring, 2012). Individual holding as an investment approach has numerous benefits. Bond, Hwang and Marcato (2012) confirm a private investor can to establish and manage individual investments as a personal income. Administration of individual investment is on a personal level and requires less paper work as compared to other investment structures like Real estate investment trusts that require joint management (Bouchouicha, & Ftiti, 2012). Individual investments especially when buying a house or any commercial property enables the investor to include capital gains to the tax return. Nevertheless, individual investments are usually much less expensive to establish and run making them tax effective. In addition, individual investments have tax advantages especially if they involve family homes (Ortalo-Magné, & Prat, 2014). Individual property in this context refers to a privately owned real estate asset, may be a rental house, a commercial building or a land where ownership is on a personal basis (Rehring, 2012). Benefits and challenges of individual investment Benefits/merits One advantage of investing directly in real estate is that it gives the investor a chance to increase his revenue through the rental benefits (Rehring, 2012). On the other hand, tax exemption is the reason as to why individuals would prefer investing in real estate as an individual investment portfolio as opposed to investing in the sector as part of the investment portfolio. Besides, the capital gains are higher with individual ownership if the real estate is operating on a private market where the investors have the opportunity to choose the prices they wish for their property. Challenges/demerits Investing in real estate as an individual vehicle offers no chance for flexibility when one needs to distribute his or her income (Rehring, 2012). Though investing in real estate as an individual vehicle is more advantageous if there are negatively geared assets, they eventually turn into positively geared thus increases tax liability in the long run (Bouchouicha, & Ftiti, 2012). Real estate investment requires proper management that is not possible to ensure through individual ownership (Rehring, 2012). In this case, the property owner must always be present to manage the property as opposed to corporate ownership of investing in real estate as part of the investment portfolio. Conversely, real estate as an investment is illiquid implying that the investment concentrates an individual’s portfolio to entirely one class of assets which is the residential real estate (Bouchouicha, & Ftiti, 2012). On the other hand, tax benefits are only realizable if an individual actively manages the rental property that is not an easy task. Why to consider direct investment in real estate In terms of capital gains, real estate is profitable since they only depend on the trends of the real estate market as opposed to real estate investments traded in stock exchanges or security markets. Besides, investing using an individual vehicle exempts the individual from tax thus the owner fully enjoys the capital gains which in this case are the profits or dividends. The opportunity to enhance performance by refurnishing the house, repairing, and maintenance offers imply that investors can use such activities to recover from losses. Most investors buy rental properties or undeveloped lands and sell or improve them quickly to gain more profits though most are speculative investment and can put investors to higher risks if the property acquisition is through debt financing (Bouchouicha, & Ftiti, 2012). Given the high possibility of illiquidity, these investment options may be inappropriate when investors do not have diversified and large portfolios. However, the property owners still have to face the challenge of high costs in terms of time and resources (Bouchouicha, & Ftiti, 2012). Compared to corporate ownership or investment in real estate, direct real estate investment may present serious management constraints that may hinder their viability or profitability. Investing in real estate as a part of a portfolio Benefits/merits In most investment options, real estate is always considered as an alternative investment when it forms the part of the investment portfolio (Magin et al., 2010). The investment approach presents many qualities that enhance the return of larger portfolios thus reduce portfolio risks within the same level of return (Rehring, 2012). One of the advantages of the investment vehicle approach is that it leads to diversification in the value of the investment. The implication is that there is well documentation of the positive aspect of diversifying the portfolio when allocating the assets (Bouchouicha, & Ftiti, 2012). In this case, real estate investment as part of the portfolio least correlates with other investment vehicles like bonds and stocks thus there are more benefits to this type of investment. As opposed to individual investment, entering the real estate as a part of the portfolio enhances yields (Rehring, 2012). The implication is that real estate allows the investor to get higher returns for the specified level of risks. Conversely, it is possible to maintain the portfolio returns while at the same time decrease the possible risks from the entire investment. Nonetheless, investing in real estate as part of a portfolio allows the investor to influence performance (Bouchouicha, & Ftiti, 2012). For instance, it is possible to replace worn out roofs, improving exterior of the building. Therefore, using real estate investment both as an individual investment or part of the portfolio offers the owners with the opportunity to control the performance of their investments. Demerits/challenges Performance measurement as a challenge is a problem to both the two types of real estate investment (Rehring, 2012). The challenge becomes more serious if the real estate property is in the private market as with the case with most real estate property ownership. The implication is that there exist no benchmarks for which real estate investors can measure and compare the performance of their portfolio results. On the other hand, measuring market risks is very difficult. The implication is that measuring return on investment and risk for both indirect and direct real estate property ownership is challenging unlike stock markets (Bouchouicha, & Ftiti, 2012). Nonetheless, it is quite difficult and challenging to build a diversified as well as meaningful real estate portfolio because purchases are spread in different geographical locations, and this may be a constraint to many investors (Hoesli, & Macgregor, 2014). However, challenge is best overcome by purchasing units in public security or private pool where a diverse portfolio supports the units. Why to consider indirect investment in real estate The capital gains might be higher when investing as part of the portfolio in real estate since there is diversification of the asset value because it has limited relations with other assets like bonds and stocks (Magin et al., 2010). Besides, investing as part of portfolio enhances yields implying that there are higher returns for the particular level of risks. In this case, there is opportunity to maintain personal portfolio returns while at the same time decreasing risks because risks always spread with joint ownership. By helping investors to hedge inflation, investing as part of the portfolio implies that an individual maintains real returns because the real estate returns always tend to increase in the inflammatory environments. Though there is the spreading of risks among the members, real estate properties traded as stock exchanges expose investors to risks of the security exchanges thus sometimes losses might be higher compared to individual ownership (Bouchouicha, & Ftiti, 2012). Methods of direct and indirect real estate investments There are few methods of acquiring property through direct investment or entering the real estate market as an individual investment vehicle. In most cases, an individual may buy a house on his or her own and assume legal ownership of the entity (Rehring, 2012). Another method of acquiring property through individual investment vehicle is buying undeveloped land where the individual may plan to resell to gain more profits or develop it to become a lifetime investment (Manganelli, 2014). In some cases, individual investors have resorted to buying a house through mortgaging. Indirect investment in real estate suits investors who wish to add real estate investments as part of their portfolios where they utilize methods for buying shares in entities or groups that own and manage properties (Rehring, 2012). One method of investing in real estate as part of investment portfolio is through syndicate as a group that buys and manages commercial properties like apartments, shopping malls, or office buildings (Gokkaya, Hill, & Kelly, 2013). The syndicate may assume various structures like corporations or rather limited partnership. When entering the real estate investment through a limited partnership, the investor enters as a limited partner under the guide and direction of the general partner (Rehring, 2012). In this context, the general partner assumes the role of managing the entire entity while the role of the limited partners is to invest in the shares of the partnership. Most importantly, limited partners become liable for the value or the amount to invest where they can lose or gain relative to the amounts they inject into the entire business (Rehring, 2012). A point to note is that limiting liability is very crucial in real estate investment since it relies mostly on debt or leverage financing. Therefore, syndicate method of investing in real estate investment is valuable to most investors because it limits their liability and also has provisions for the management of the property (Bouchouicha, & Ftiti, 2012). On the contrary, entering real estate as individual investment vehicle poses management challenges since an individual may find it tedious to own and manage the property or may lack the skills for managing the entity. Another method or approach to investing in real estate as part of the investment portfolio is through real estate investment trusts or REITs as mutual funds of the real estate holdings (Block, 2011). In this case, the investor buys the REIT shares that are either privately held or traded publicly on the stock market exchanges. Since REIT collectively involves funds that are invested in various commercial entities, there is the high possibility of spreading risks as opposed to individually owned real estate property (Cotter, & Roll, 2014). Some real estate investment trusts specialize in specific properties like vacation properties, shopping malls, and apartments. Conclusion In summary, investing in real estate using both individual investment vehicle and part of the investment portfolio opens opportunities for both individual and corporate investors. Individual real estate ownership has the advantage of increasing the overall income of the investor, which is the net revenue accrued from the real estate business and other investments, and also exempting him or her from taxation. However, the investment approach present property management and risk challenges that may hinder the property from recording any profit. On the contrary, investing in real estate as part of investment portfolio spread risks among investors and overcomes property management challenges and issues. Bibliography Allen, F, & Carletti, E 2013, ‘Systemic risk from real estate and macro-prudential regulation’, International Journal of Banking, Accounting and Finance, vol. 5, no. 1, pp. 28-48. Block, RL 2011, Investing in REITs: real estate investment trusts (Vol. 141), John Wiley & Sons, Hoboken. Bond, SA, Hwang, S, & Marcato, G 2012, ‘Commercial real estate returns: an anatomy of smoothing in asset and index returns’, Real Estate Economics, vol. 40, no. 4, pp. 637-661. Bouchouicha, R, & Ftiti, Z 2012, ‘Real estate markets and the macroeconomy: a dynamic coherence framework’, Economic Modelling, vol. 29, no. 5, pp. 1820-1829. 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