INVESTING IN REAL ESTATE. TODAY A BROAD AND COMPLEX PROCESS.
Investing in real estate with the goal of making a living through renting and putting it to income is now a financial activity that needs preparation, expertise and excellent intuition starting with what and where to buy or redevelop. The process is not trivial when approached with rationality and prudence as any business activity requires. For the small private investor, the starting point is often to consider the use of a certain amount of disposable money or a wealth of real estate received in inheritance. The most recurring, not to say naïve, dream is to be able to live off of rents all the time, but provided that the minimum threshold of available real estate capital is now at least 1.5 million euro.
According to some Bank of Italy studies and pre Covid/Ukrainian conflict estimates, with that amount of money to invest in bricks and mortar, one could get a monthly income of around 6,000 euro or so. Offering a good yield, however, are properties located in large financial or commercial cities or even renowned tourist centers and especially if in areas with a high rate of redevelopment or land development. Also worth considering is the possibility of diversifying into real estate areas abroad that could act as a buffer to country-to-country fluctuations from Italy.
Just in Italy the residential sector is at a minimum stage, that is, with prices below 2007 values, a unit value of properties below pre-pandemic levels and a decrease of -3% on average, in the unit sales price (Idealista). The rental sector, on the other hand, is growing, with a steady improvement in unit price value since 2007 and a +0.06% in unit rental price compared to 2020. Despite the difficulty faced by the residential sector, the unemployment rate rising from 10 percent pre-pandemic to 9.2 percent in 2021 has led to an increase in relative demand, both in purchases and rentals. Housing supply has also increased, rising from 3 percent in 2020 to 3.1 percent in 2021.
Current crisis dictates new conditions
With the recent events of the war between Russia and Ukraine, the continuing pandemic, and the sharp rise in energy and raw materials, the real estate investment sector is nevertheless going through a period of uncertainty due especially to the fear of a new recession. This economic fragility will especially have more immediate effects on new construction. The heavy weight to bear in the coming periods will be inflation trends. For small investors, with respect to this trend, there will be more difficulties both in terms of buying and selling, in terms of renovations, and in terms of rental values, which will also be affected by the diminished purchasing power of families, who will be faced with “high rents.” So demand will be skimmed off and rent/release times will tend to stretch even much longer. Less critical is the situation for large investments that can count on a large amount of capital that can absorb — at least in the short/medium term — the crisis situation. Another critical element is the increase in mortgage interest rates, now decreed by the Central Bank and which will have a calming effect on the demand, mortgages and building interventions. There is also market demand to consider, which at this time could impact the high-end housing market in relation to luxury second homes in tourist areas, especially abroad. Yet if the war slows demand apparently does not seem to have impacted prices. The investment choice could go to homes for renovation at a more competitive price and with the prospect of tax incentives to refurbish them and put them to income. Investing with discernment.
From recent surveys, the Italian provinces with the sharpest price decrease in the residential sector were Oristano, Isernia, Forli, Sondrio and Biella. By contrast, prices in the most sought-after cities such as Milan, Florence and Venice hold. The highest market demands are concentrated in Rome, Milan, Genoa, Palermo and Messina. Rising costs in large cities lead to increased sales in suburbs or small towns. In a country where real estate can lose up to 20 percent of its value due to inflation, involve a great deal of expenses and taxes, and where taking out a mortgage means creating a large debt with a bank, effectively “losing” or locking up liquidity that could be invested in something else, this idea of the easy and lucrative investment cannot exist. Making real estate investments is a financial activity in its own right, which includes the use of risk capital, is based on a risk-return rationale, and is aimed at generating profits. The ways by which to produce capital gains or obtain good rents, passes through real estate flipping operations that consist of buying properties at low prices, sold by banks or auctions or in suboptimal condition (hence the low cost compared to the market), and renovating them, with the aim of increasing the value of the house in order to sell it at a higher price and obtain profits or still put on the market at attractive rents capable of ensuring a valuable recurring income.
It is possible to draw a parallel by saying that investing in real estate is a financial action that resembles, in a sense, an investment in bonds. In fact, in both cases we have:
- a capital sum paid in at the outset;
- a recurring annuity;
- a taxation on the annuity;
- an initial capital value that fluctuates over time;
- a total return as the sum of plus/minus on the principal and a periodic annuity.
Of course, the differences are there and they are also substantial. For example:
- while a bond can be sold with a click, the same cannot be said of a property;
- in bonds the repayment of principal occurs at maturity, while there is no maturity for real estate;
- we have a certain nominal redemption value for the bond, but no certainty about the redemption value if the real estate is sold;
- the bond investment can be made with significantly less capital.
Therefore, the methods of assessing the profitability of a real estate investment can be similar to those used to evaluate the return on a bond investment. There are on the market solutions that can be considered hybrid, for example lending crowdfunding is based on the already known principle of crowdfunding and that is the collective collection of funds, for the realization of a project. At the conclusion of the project, the lender is paid back the principal, with interest. The risks certainly can be diversified by carrying out several transactions at once, although the real underlying risk typical of real estate investment remains the same.
In the case of Financial Funds, these are financial instruments that are concerned with investing not less than 2/3 of one’s assets in the purchase of real estate, interests in real estate companies, or real estate rights. Usually these types of funds have a very long duration and offer redemption only when the contract expires. Then there are ETFs related to the real estate market, as well as numerous publicly traded companies involved in selling, building or renovating real estate. It is therefore possible to buy the real estate shares of these companies through a diversified instrument (the ETF Exchange Traded Funds), or directly by buying the shares of individual companies.
To every investment its own risk.
Real estate is a very complex industry, and its market presence is determined by an infinite number of variables and elements. As a result, real estate investments are also subject to great complexity and variability. For example, we can say that the health of an investment in real estate is generated by factors such as:
- the demographic curve: the more young people there are around, the greater the interest in renting and buying real estate;
- labor mobility and employment rate: the more people in stable employment, the greater the tendency to buy real estate;
- the more people have an incentive to move from their hometown to work, the greater the demand for apartments and rentals;
- the growth in per capita income: as is normal, more wealth leads to greater demand for houses, both to rent and to buy;
- the general attractiveness of the country and the area in which the real estate investment is made;
- the growth of GDP: the increase in jobs, employment and general productivity is matched by growth in real estate demand;
- the tourist attractiveness of the country: if the area is able to capture the interest of many people it will have a thriving and attractive market.
Unfortunately, we cannot predict the future and have exact predictions of how all these factors will evolve-that is why being aware of what the risks are in this area is important. Knowing market trends is always important, but in real estate it is even more if you have a plan to “lock in” your venture capital in a property and use it to generate profits.
Edited by reFRAME Editorial Staff
