Elizar Bubnov, Director Cross Asset Structuring, Dimension Investments
Any comparison of real estate investments with investments in exchange traded funds (ETFs) is – at first glance – risky. As the classics say: let’s not compare apples with pears. On the other hand, both ETFs and real estate are instruments to invest in. It is difficult not to find common elements for these investment options, and even find advantages to confirm the rightness of the decision of real estate investment supporters or to draw attention to other investment opportunities, which include, among others: ETFs.
I don’t think we need to introduce real estate, because most of us deal with it every day. ETFs, on the other hand, are products (they can be purchased through investment firms) that reflect stock exchange indices like S&P 500, Nasdaq or any others products, including commodities (ETC).
Stock exchange investments, such as ETFs or shares, are still untouchable, not material ways of investing for the average investor. Real estate is different – we can see it and touch it. This is why we tend to invest more in tangible real estate than ETFs. We know everything about real estate. Only a few have heard about ETFs. Additionally, 4/5 of the local population has no knowledge about investing in the stock market, and 1/5 is simply afraid of it. ETFs became most popular in the USA. The assets invested in them by Americans far exceed those invested in traditional funds.
ETFs are funds whose shares are traded on exchanges just like regular stocks and bonds. These funds are managed by professional asset managers who invest in a wide range of financial instruments in accordance with investment policies strictly defined in the fund’s issuance documentation. ETFs are extremely popular investment instruments around the world, especially in the developed markets of the US and Europe.
In most cases, the main purpose of an ETF is to provide its shareholders with the opportunity to gain access to some investment strategy in the most convenient way.
Let’s imagine that the client wants to buy not one specific US stock (for example, Apple or Tesla), but the broad US stock market, without having millions of dollars to build a large portfolio that follows the structure of the market, but having, let’s say, just 20 dollars. He/she then purchases a share in ETF that invests in all 500 stocks in the S&P 500 index, gaining exposure to the U.S. stock market as a whole.
Or the client wants to buy gold, but does not want to physically store it at home in the form of jewellery and coins, or in the form of bars in a bank safe. He/she can buy shares of an ETF backed by physical gold held securely in a reserve bank in the name of fund. By the documents, the client in this case becomes the owner of part of this gold!
The asset managers of these ETFs are usually well-known, reputable companies, the most famous of which are Blackrock, Vanguard and State Street, with trillions of dollars in assets under management.
Recognition: real estate vs. ETFs – 1:0
Goal: investment horizon
Determining the investment goal is important for every beginner (and not only) investor. There are both short-term goals – saving money for next year’s holidays or other pleasures, as well as long-term goals – retirement, an easy start for our children or accumulating capital for the future. Due to the long perspective, it is difficult for us to set a goal – the foggy future, often no perspectives and unannounced expenses prevent us from having a long-term option.
In Poland, for example, following the latest reports (multiple choice), 65% of Poles indicated the so-called goal of saving money for – a rainy day and securing the future. For 32%, the purpose of saving money is for recreation and holidays, for 25% – for home furnishings and renovations, and for 21% – for retirement security. Both buying real estate for profit and investing in ETFs could be long-term investments. Of course, we will find exceptions here, created by investors who play (invest) on the stock exchange every day and monitor the market, and real estate speculators (in positive meaning, as a part of the market) who buy apartments to renovate and resell at a profit. However, different ETFs can provide an investor with a very wide range of solutions in terms of investment horizon: some may be suitable for long-term goals, others for speculation.
Investment horizon: real estate vs. ETFs – draw
Preparation for purchase – analysis
In the case of both investments, it is important to choose the right solution. There are over 9,000 ETFs in the world. Blackrock which is the biggest ETF provider in the world with $9.1 trillion in assets under management has 427 ETFs traded on the US markets. And the offer of real estate in general is also very huge. In 2022, about 48,000 real estate purchase and sale transactions were completed in Armenia and about 4 million in USA. Unfortunately, it is not known what part of the property was purchased as an investment.
In order to choose the right long-term solution for us, we must analyse the markets:
• real estate – local or foreign market, large or small cities, what type of property: house, flat or apartment by the sea or in the mountains, price per square meter, historical price changes, attractiveness, transaction costs, currency and, of course, expected profit,
• ETFs – local or foreign market (large or small), large or small companies, shares, bonds, specific sectors or broad market, commodities (gold, industrial metals, oil, gas, wheat or even coffee beans), real estate ( also available in ETF’s! ), price, historical price changes, expense ratios (fees of fund asset managers), transaction costs, currency and, of course, expected profit.
We should approach the purchase of these investments using the same methodology. Obviously, psychologically or “by instinct”, it is easier for us to navigate the properties we live with every day. It’s necessary to remember not to buy using only wishes and impression, but with our minds and calculated analysis. We can also use expert advice or be supported by publications of experienced people related to the industry.
Investment analysis: real estate vs. ETFs draw
Purchase process
Most real estate advertisements can be found on websites that we must visit or log in to. Of course, we can go to the developer of our choice for information and an offer. If we have the knowledge and skills to purchase a property (checking land and mortgage registers, collecting documents from a developer or seller, comparing prices in the area), we make the purchase ourselves, if we do not feel up to it – we use the help and services of a recommended real estate advisor, often called an intermediary. It is similar with investing in ETFs.
Listed funds can be found in the offer of many investment firm) and opening an account can be done using both a telephone and a computer. Of course, you can go to a meeting at the investment firm of your choice to obtain information and an offer. We can purchase ETFs without leaving home, and the transaction itself, after transferring funds to your brokerage account, should not take more than 5 minutes. In the investment firm, we can use the services of experienced analysts and managers. If we have knowledge about investing through a investment firm, we certainly have such a brokerage account and we can start investing in ETFs immediately.
The process of purchasing real estate is more time-consuming than that of ETFs and involves spending time on viewings, signing contracts, and additional expenses for finishing. Both well-proven investments are transparent – we know what we are investing in. The property is usually checked by a professional broker or notary to check whether it has any legal defects.
The purchasing process: real estate vs. ETFs 0:1
Investment costs
We spend much more money (average and in general) on real estate than on stock market investments, so we also have to take into account higher costs. Those relating to the purchase of real estate include not only the purchase price, but also other expenses related to the purchase, e.g. notary’s remuneration, tax on civil law transactions. Expenditures that increased the value of the property include, e.g. expenses for the modernization of the premises.
The larger the investment amount when purchasing ETFs, the lower the transaction costs. Their purchase includes a brokerage commission charged by the investment firm as well as custody fee that is paid regularly for safekeeping of ETF shares. In addition, each ETF has what is called an expense ratio, which includes a management fee (the asset manager’s remuneration) and the administrative expenses of the fund and its manager. Such fees can be as low as a few basis points (0.05-0.10% per annum) in the case of large popular funds linked to bonds or broad stock market portfolios, and up to several percent in the case of more exotic strategies. However, in most cases overall costs related to ETFs are relatively low.
Stock exchange-listed funds are one of the cheapest solutions available on the investment fund market. They are a cheaper solution, and the costs we incur are much lower – brokerage commission, custody and management fees. The real estate costs include: agent’s commission, notary costs, taxes and the costs of finishing the apartment, insurance costs and operating costs.
Costs: real estate vs. ETFs 0:1
Profits
The fact that a given property or a given stock market index has seen increases in recent years does not mean that the following years will also bring us profits. On the part of the investor in real estate and ETFs, there is a long investment period.
What determines the price of real estate?
The price of real estate is determined by interest rates and margins on mortgage loans. Cheap money encourages people to buy real estate. Low interest rates also affect deposits and bonds; they are unattractive compared to investments in rental apartments.
The price of real estate is also influenced by: the high cost of renting an apartment (loan profitability), the increase in the wealth of society, the high percentage of people living in overcrowded apartments and people living with their parents (in the family home), strong local demography – the number of inhabitants in the city is increasing, demand support programs , e.g. attractive loan, high economic and political stability of the country, high immigration to the country and a given city.
What determines the price of the ETF?
The valuation of an ETF depends on the valuation of its underlying assets, i.e. gold price, oil price, or price of shares included in the index that the ETF mimics. If our fund is based on an index of American or local companies, the condition of these companies will affect their price, which will affect our ETF.
Listed funds include not only shares, but also bonds, commodities and real estate collected in indices around the world.
Profit prospects
We do not know how the real estate market in the country will develop and whether investing in real estate will bring us large profits. Assuming that we buy an investment property only for rent and without using a loan in a large city, we will certainly achieve these profits in a good location. The average profit from renting a flat in Poland is approximately 5% and if we add the increase in the value of the flat, it may turn out to be a profitable investment. The decline in the profitability of our investment will be influenced by: the use of credit, depreciation and the age of the property.
Based on publicly available data, it is estimated in Poland that the apartment growth over the last 10 years is approximately 76%. There were also temporary price drops during this time – the so-called corrections.
When it comes to ETFs, we can choose among them. . If to analyse stock market ETFs we can see that the S&P 500 index including dividends of American companies has earned 185% over the last 10 years, the Nasdaq index of American technology companies – nearly 350%. The Polish index of medium-sized companies mWIG40 with dividends has allowed for earnings of approximately 100% over the last 10 years, and sWIG80 – approximately 90%. Of course, in this example, investors had moments during this period when their investment was below the purchase price.
The average market value of real estate in apartment buildings in Yerevan in drams in the third quarter of 2023 was 9.4% higher than a year earlier. Taking into account the strengthening of the dram against the US dollar during this period, this corresponds to a yield of 15% in US dollars. That’s higher than gold’s 10.8% return, but lower than the S&P 500’s 19.7% return over the same period. Investments in both gold and S&P 500 could be done through ETF shares.
The returns on both investments are comparable and may vary at different times. Both real estate and ETFs can be profitable solutions for investors. The profits of both investments are comparable. It’s hard to say anything about the future because opinions are obviously different. Developers, real estate agents will claim that property prices will increase. Supporters of the stock market and ETFs predict that we will soon face a crisis on the real estate market.
Profit: real estate vs. ETFs draw
The risk
The risk when purchasing both real estate and ETFs is similar – we may lose part of the invested funds. If it turns out that the loss on the investment has reached a level that is unacceptable to us, the time needed to sell the property will be much more time-consuming. We can sell listed funds when we log in to the investment firm and enter the price at which we want to exit our investment. We can sell any part of the funds invested there. However, if our strategy and belief in growth are strong, we can buy ETFs by averaging the price. In the case of real estate, we would have to have a lot of cash to buy another apartment, not to mention the fact that it is not possible to partially leave the property.
Risk diversification in the case of ETFs could be much greater due to the number of funds and the composition of the index. Example: The S&P 500 ETF invests in the 500 largest US companies. We can purchase several based on different markets, countries, commodities. When it comes to investment in real estate, you need to invest large amount in one object. The average price of an apartment with an area of 60 square meters in Yerevan in the third quarter of 2023 was about 64 thousand dollars. With 64 thousand dollars you could build a diversified portfolio of ETFs having exposure to different markets and instruments. And let’s not forget that real estate is a highly cyclical sector, sensitive to economic downturns, and with ETFs you can invest even in uncertain times in instruments that can outperform falling markets.
Another important point is liquidity. Selling your home quickly can be challenging, and usually the faster you want to sell it, the more discount you have to give. The largest ETFs have tens of billions of dollars in daily trading volume, so exiting an investment can take a matter of seconds. The settlement period is typically between zero and two days depending on the market, so you may see cash in your bank account almost immediately after the trade is done.
Being liquid market instruments, ETFs can allow you to raise margin funding (leveraged money) through your broker. Real estate can also be used as collateral to attract bank loan money, but this process will take much longer. However, in case of real estate credit rates are usually lower.
Response time, diversification and access to your investment are to the advantage of ETFs.
There are many more similarities in investing in real estate and ETFs:
• You can seek professional support or contact someone who will help you with the transaction.
• You will need to pay tax on both investments if closed with profit.
• We can observe the investment not only in visual terms (apartment or the value of the brokerage account), but also price changes. When it comes to investing in ETFs, we have very detailed information about the current price or history of price changes. In the case of real estate, they are more contractual because they are negotiable.
To sum up: both real estate and investing in ETFs could be suitable investment solutions. Each action aimed at securing our future and investing our surpluses in financial market instruments or real estate, commodities, art etc. is an action that requires acquiring knowledge and thorough analysis. We also need to take the advice of professionals to protect ourselves from mistakes.
Let’s not put all of eggs in one basket. Most wealthy and experienced investors, such as Bodo Schafer and Warren Buffet, say that you should set aside at least 10% of your income for investments. And it is a good rule regardless of whether it is real estate or an ETF or even both. As mentioned at the very beginning – comparing apples with pears? But let’s not forget that apples do not exclude pears, but they diversify our menu.
