Is it a good idea to invest in real estate?

Why is investing in real estate an attractive option for some investors?

Those who are fortunate enough to have some money in their savings account and would rather put this money to work, may wonder whether or not it is a good decision to invest in real estate by buying a house other than the one they live in, and with that comes the question of how much to invest in housing and whether it is a good time to buy.

In the Netherlands, we are currently facing a huge housing shortage; demand for housing exceeds supply. In addition, money has become considerably more expensive in recent years due to inflation. We discussed earlier in this article that when inflation goes up, interest rates usually rise with it. Mortgage rates rose from an average of 1.6% to 4.3% in 2022 and 2023 and have since (2024) fallen to around 4.0%, according to PwC in their 2024 report on real estate developments in our country. Interest rates have stabilised, according to the report, with a slight decline to be expected towards the end of 2024. The analysis also highlights the lowering effect of higher mortgage rates on house prices.

Buying a second home or flat can be a way to build wealth and an option for those seeking long-term financial security, but it also comes with a number of obligations, drawbacks and risks. In this article, we look at the pros and cons of 'investing in bricks and mortar', as it is more commonly known, and learn about possible alternatives to benefit from the growth of the real estate market, such as investing in real estate ETFs.

Advantages and disadvantages of buying a house as an investment

Home ownership has a number of advantages, for instance the generation of passive income and potential appreciation in value. We will discuss the benefits below.

• Passive income: Passive income can be generated after the purchase of a house, for example through monthly rent if it is rented out. This passive income has the added advantage of being predictable, allowing investors to do relatively accurate financial planning.
• Capital gain: The value of the property may increase over the years (in the Netherlands, for example, the average house price in December 2023 increased by 1.6% compared to the previous year), which creates a capital gain, i.e. the positive difference between the price at which we bought the property and the current market price. The average selling price of existing homes now stands at around €422,400 (Source: CBS).
• Potentially higher returns: If the property is purchased at a competitive or even affordable price and/or is improved over time, for example by adding better insulation, solar panels or an extension, the economic returns can be high.
• Personal or family use: The property can be made available to a child once they move out or used as a home for another individual/couple/family, providing a stable, secure housing solution in a time of housing shortage.
• Asset security: By extension - having a tangible asset such as a (second) home can provide a sense of stability and security, an important aspect for those who also see their investment as a future legacy.

Disadvantages

On the other hand, buying a second home as an investment also has certain drawbacks, such as the need for substantial savings for the initial purchase or the risks inherent in this type of investment.

• The need for a significant budget: Buying a house or apartment usually requires a mortgage loan and a personal deposit (usually around 4-6% of the value). This is a transaction that requires quite a bit of savings and a stable regular income. Also to be considered are the costs of maintaining a second home, such as any service charges, council tax, maintenance and repairs; water, electricity, gas and other utilities; any remittance or leasehold; insurance, or the mortgage payments itself.
• Lack of diversification: By investing in a single property, you expose yourself to area-specific risks. For example, an increase in crime, the closure of large businesses or prominent shops in the neighbourhood, or new infrastructure that makes the area less attractive (such as a motorway or landfill) can lower the value of the property and reduce its attractiveness to tenants.
• Other risks: Both buying and selling and leasing real estate for investment purposes are operations that involve risks, for example risks arising from possible changes in the economic climate or the financial solvency of the owner or its tenants. You may have to deal with non-paying tenants as a result, for example.

Investing in property through the stock market

For those who do not have the means or willingness to accept these risks, there are alternative ways to benefit from the growth of the property market, at a lower cost and without the liabilities associated with buying property. Below, we discuss two such possibilities.

Real Estate ETFs

This can be done, for example, by investing through ETFs (exchange-traded funds) focused on real estate. ETFs offer a transparent and broadly diversified way of investing and require less capital, including real estate ETFs. Real estate ETFs track the performance of indices containing companies engaged in the development and operation of real estate.

REITs

Besides 'regular' ETFs focused on real estate, there are specialised real estate-related service providers and real estate investment trusts (REITs) in which you can invest, which are usually involved in different types of real estate. REITs generate income by managing and owning real estate assets, which can be traded on the stock exchange. This type of investment offers the opportunity to generate income from property but without having to buy, manage or finance it. REITs are owners or lessors of all types of real estate (flats, hotels, offices, warehouses, etc.) and by investing in a REIT, you are indirectly investing in the real estate assets owned by the fund. REITs pay out investors in the form of dividends or you benefit from the increase in value of the shares. For example, one of the requirements to qualify as a REIT is the obligation to distribute most of the taxable income to shareholders, usually a percentage of around 90%. It is also possible to invest in REITs through ETFs, so-called REIT ETFs.

Conclusion

Investing in residential property can be an option for investors looking for passive income and long-term capital gains. However, it should be borne in mind that this investment requires significant initial capital and involves risks related to the future of the property market. Alternatives such as real estate ETFs and REITs offer access to the real estate market and an opportunity to benefit from the growth of the sector without actually having to buy real estate.