Asset allocation and diversification are two of the most important keys to the long-term growth of your investment portfolio, forming the basis of your stable yet profitable financial strategy. The Talmud (Bava Metzia 42a) mentions that one should divide one’s assets into three main asset classes: real estate, business (including stocks) and cash. This month I’d like to discuss how real estate fits into your investment plan and how you should look at the equity that you’ve built up in your home.
Buying a home is generally one of the largest business transactions that people make over the course of their lives. By owning a home and paying off a standard mortgage (no matter the size or duration) one creates equity, which is in essence a long-term savings plan (with both you and the bank profiting in the long run). But because most people do not buy and sell their property on a yearly basis, the value of one’s home is generally not the critical factor. It’s more important to ensure that you can afford to live in your home than to worry about whether its value has appreciated. In general, I recommend that people discount the value of their home when looking at their investment portfolio. Your home is not an asset that is easily liquidated and will not provide funds that can be accessed for emergencies. Since you need to live somewhere, your home should be considered your castle and not a way to raise money for other investments.
Investors often are convinced to borrow against their property in order to buy additional properties to generate more income. While this investment strategy can work in certain investment environments, such as during the western world’s real estate bubble of the previous decade, it doesn’t always work and this strategy raises one’s level of risk by increasing financial leverage (as your equity remains steady and your debt grows). Real estate, like all assets, is always in equilibrium with sellers receiving what buyers are willing to pay, right now. Prices can move in unexpected directions for many different reasons. While you might be convinced that real estate is going up, you always risk continued or additional losses in the value of your property, the longer you hold on to it.
According to new statistics published by the TaubCenter for Social Policy Studies in Israel, housing in Israel is more expensive than in 174 out of 175 large American cities (comparison based on numbers of years of work needed to purchase a home). Real estate prices in Israel have risen steadily over the last four years, with prices of apartments increasing by approximately 50-60% over that period of time. In some locations, price increases are even higher. Rents and nominal wages, in contrast, have only risen 15-20% during this same period, leading many an analyst to believe that Israel is also in real estate bubble territory.
So if your home shouldn’t be considered as part of your standard investment portfolio where does real estate fit into your portfolio? There are a number of ways for individuals to consider Israeli real estate investments.
- Buying apartments to rent out has been a favorite investment vehicle for decades in Israel. While ren t-to-value ratios (ie , the amount of money you earn as a percentage of the value of your property) in Israel are low, earning between 2-4% of t he value of the property per year, consistent appreciation in real estate has made it worthwhile. (As a comparison, in many western countries the rent-to-value ratio can range between 6-10% annually) Rental income is also made even more attractive by the rental income tax exemption in Israel (4,790 NIS a month). But being a landlord is not for everyone as it can take time energy and money to manage a property and there is no guarantee that it will appreciate in value.
- Partnering with others to buy a property. While some might contribute more money, others are often able to compensate by doing more of the day-to-day management.
- Invest in real estate through the Tel Aviv Stock Exchange (TASE). There are many real estate companies and even a Real Estate Investment Trust (REIT) traded on the exchange that gives you the ability to invest in real estate for very small sums of money (as little as a few thousand shekels). A financial interest avoids much of the bureaucracy of real estate investing like contracts, negotiations, maintenance costs and management fees. The high level of liquidity means that you can buy and sell your interest on a daily basis and the investment is generally not correlated to a standard stock and bond portfolio.
Traditionally, spring is when the real estate market becomes more buoyant. Whether you look to the property market to buy your primary residence, a second home, or an investment package, ensure that your investment meets your personal investment needs and fits into your overall portfolio strategy.