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The Problem

Historically, real estate investors can expect an average APY of 7%(Jordà et al.). There are, however, many details hidden behind this figure. For most people, real estate investments are inaccessible, are very risky and require much more effort than other types of investments. Below, we detail some of the biggest problems faced by those choosing to invest in real estate. 


High starting costs

 

Real estate investments have a notoriously high entry cost. In some countries in Europe, the house price can be up to 145 times the local annual income(“Income to House Price Ratio in Europe |European House Price Income Ratio”). This is much larger than the investing budget of the vast majority of people. Trends suggest that real estate will become less accessible over time in the vast majority of european countries(Deloitte). 


In order to finance this purchase, most people would have to take out a loan. However, there are multiple problems with this approach: 

● Risk of default - due to changes in income, the person may not be able to pay back the loan 

● Lower return on investment - an average yearly interest of 5% means that a property that would normally break even in 10 years, does so in only 30+ years 

● External Obsolescence - due to factors outside the owner’s control, the property price (or prices in the entire neighbourhood). Neighbours can often lower the value of a property by 10-24%(Colwell et al. 625-626). 

● Risk of market downturn - as seen in the 2008 mortgage crisis, the entire real estate market can drop. 


Impossibility of Diversification 


For most people, taking out multiple loans in order to purchase multiple properties is either not possible, or at the very least extremely risky. 


Thus, since one cannot diversify between multiple properties, a person investing in real estate has many risks, many of which are outside his/her control. These are, among others: 

● Location risk - Possibility of real estate price drops at or around the property location 

● Risk of unforeseen problems with property


Lack of Real Estate Knowledge 


Investing in real estate requires a very specific skill set, which most people starting out just do not have. Precisely, it requires: 

● Real estate specific knowledge 

● Deep understanding of the local economy / market 

● Knowledge of legal requirements and a business plan.


Without the necessary knowledge, there is a very large risk of overestimating the value of property, paying significantly more than market value and thus losing money. On the other hand, without a good plan in place, even great value purchases can fail to bring the expected profit. Lack of awareness of the legal requirements can lead to fines and other types of penalties, making the investment not worthwhile


Lack of Knowledge of Legal Requirements 


Investing in real estate requires knowledge of the legal requirements. These legal requirements add to transaction costs, raising the de facto cost of acquisition. In Europe, these range between 3 and 21%, with an average of 10-12% per round trip (buying and selling) (Druica et al. 419). Ignorance of these canlead to large fines or even more serious consequences. 

Due to differing legal requirements, it is very difficult for an individual to purchase real estate in another country.


Large Management effort 


People purchasing real estate are often surprised by how much effort managing a property entails. Besides the above mentioned knowledge that must first be learned in order to effectively invest in real estate, there are many more activities needed to monetize the investment. Real estate is rarely a passive investment. 

Different activities necessary requiring time and/or money investment when renting out a property: ● Finding and vetting tenants 

● Registering the rent contract 

● Payment collection 

● Maintenance and repairs 

● Updating and improving property 


Standard professional property management fees are between 8-10%(Harmon and Griswold 77). The high time costs make managing the property yourself not worth it (McElroy 56

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