The Basics of Real Estate Investing — Direct vs. Indirect
When you think of real estate investing, does only 'buying an apartment or a storefront' come to mind? In fact, there are ways to invest in real estate with just a small amount. Let's look at how it breaks down.
Real estate investing splits broadly into two
The ways to invest in real estate broadly divide into 'direct investment' and 'indirect investment.'
Direct investment means literally buying physical real estate under your own name. This includes residential properties like apartments and officetels, commercial properties like storefronts and offices, and land. You own it directly and rent it out or resell it.
Indirect investment means buying a 'security' that holds real estate. The representative examples are REITs and real estate funds. Many people's money is pooled to invest in a large building or logistics center, and you own a slice of it, split like a stock.
In short, direct investment is closer to buying 'the whole building,' while indirect investment is closer to buying 'a slice of the building.'
Direct investment: large capital and a management burden
The advantage of direct investment is that you fully own and control the asset. You can rent it out to collect monthly rent, or resell it for a gain when its value rises. Many people also use a loan (leverage) to manage an asset larger than their own money.
But the threshold and burden are high. First, you need a large sum of money; when buying there are acquisition taxes and brokerage fees, and while holding, property taxes and maintenance costs keep coming out.
Also, if there is no tenant (vacancy), income stops, and if you used a loan, the interest burden grows when rates rise. Above all, a major characteristic is 'low liquidity'—you can't sell immediately when you want to. A stock sells in seconds, but a house can take months.
Leverage (a loan) magnifies gains but also magnifies losses. If home prices fall and rates rise, you could suffer a loss larger than your invested principal.
Indirect investment: small amounts and liquidity, but share-price swings instead
Indirect investment, especially REITs, greatly lowers the threshold of direct investment.
REITs are listed on an exchange and can be bought and sold like stocks, so with just a small amount you can make a 'slice investment' in a large office or logistics center. Liquidity is high, so it's easy to sell when you want, and a professional management firm handles it, so you don't have to wrestle with tenants yourself. A characteristic structure is that most of the rental income is distributed as dividends.
But there are downsides too. Because REITs trade like stocks, their prices swing with market conditions. In particular, REIT share prices tend to be pressured during periods of rising interest rates. There is also a fee paid to the management firm, and the dividends you receive are taxed.
It's a misconception that 'indirect investment is safe.' REITs can fall like stocks, and in fact they have suffered large drawdowns during real estate downturns.
Either way, you must look at the 'hidden costs and risks'
Whether direct or indirect, what matters in real estate investing is looking at the costs and risks behind the return you see on the surface.
Direct investment hides taxes, fees, vacancy, and liquidity risk, while indirect investment hides share-price volatility, interest-rate sensitivity, and management fees.
The perspective this service emphasizes is the same. When you look at 'if I steadily held a good asset for a long time, how much would it be now?', for real estate too you must weigh not only the rise but also the maximum drawdown, the recovery period, and the costs together to see the true picture.
Frequently Asked Questions
Q. I don't have much money—can I start investing in real estate?
Buying physical property directly requires a large sum and a loan, but indirect investments like REITs can be started with just a small amount. However, 'possible with a small amount' and 'no risk' are different. REITs can fall in price like stocks, so even with a small amount it's good to check the maximum drawdown, dividend taxation, and management fees.
Q. Isn't real estate a safe investment since it always goes up?
'Real estate never fails' is a dangerous belief. There are many cases where prices fell or stagnated for a long time depending on the region and period, and if you used a large loan, losses can exceed your principal during a downturn. There is also liquidity risk—you can't sell when you want to. No asset comes with a guarantee that it 'always goes up.'
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