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Three Challenges With Real Asset Investments - And How To Work Around Them
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Learn how to work around these three primary problems with real asset investments.
Illiquidity, a lack of expertise and the unknown dynamics of the marketplace all affect the growth of real assets. Smart investors know how to minimize their exposure.
Investors have been diversifying their portfolios with greater enthusiasm since the financial crisis of 2008. Given the failings and vulnerability of market-traded securities, they are increasingly adding real assets to their financial planning, finding asset growth in such things as precious metals, art and antiques, raw and developed land and hedge funds.
But real assets are like any class of investment: each has its challenges – which makes sense, because if there were no risk there would be little reward. For any investment to be worthwhile – even if it is daunting to the feint at heart – it must come with some vulnerabilities. The smarter investor can then pick his or her way through those challenges and figure out ways to mitigate risks.
One of the best illustrations of this is land investing. Every property, particularly land tracts that are undeveloped, has a truly unique set of variables while being subject to national economics and even to some extent the global economy. Consider the three primary challenges to land investing – illiquidity, asset knowledge and marketplace dynamics – and some ways that these investment risks can be minimized or even eliminated:
Illiquidity – There are two conflicting theoretical arguments about economics. One is that, essentially, everything is for sale, and that every product has a buyer. But in fact, there is friction in all markets that slow things down and prevent buyers and sellers from doing neat, instant transactions. Market-traded securities are perhaps the best examples of very liquid assets, yet trading halts and high bid-ask spreads can slow even those down.
Greater illiquidity happens with real assets such as land, of course. Land investors sometimes anticipate it will take several years for the asset to reach an adequate value increase before attempting to sell it, and then the legal matters relating to the transaction generally takes months to execute. Rare antiques, art, precious metals and other real assets have similar challenges in that the transactions involve certain factors that slow the actual sale of the asset.
Asset knowledge – Art dealers make a handsome income for a reason: they understand art and art values. The same can be said about antique cars and other fine collectibles. Each requires deep knowledge of the asset class itself, as well as the current dynamics that affect near- and long-term values.
Using the same example of raw land, knowledge of the investment and all factors affecting it require expertise on the part of the investor. To this point, it should be noted that fraudulent schemes have promoted worthless land to unsuspecting investors. Anyone investing in land should have skills in site evaluation and planning, and be able to gauge municipal planning authorities’ propensity to rezone land for alternative uses (typically, authorizing it for residential or commercial development). The land investment expert will also be able to judge how much time will be required to turn raw land into something of greater value – enabling investors to understand how long they must wait to see a return on their investments.
Dynamics affecting value – To see where world events can affect the price of a real asset look no further than what has happened lately to the price of gold. Between October 2012 and February 2013, prices tumbled from a high of $1800 (USD) per ounce to $1600 per ounce – after a 481 percent increase from 2002, when it traded for about $275 per ounce, the biggest gains coming after the 2008 global financial crisis.
Historically, gold prices have mirrored the ups and downs of interest rates, but other factors have played a role in the stratospheric increase of gold in the past decade. These include a slowing global economy, sovereign debt problems worldwide and the downgrade of U.S. debt, as well as fears tied to deficit spending by governments.
Land investment in the UK is currently driven by a distinct housing shortage. While it remains difficult for many young people to get adequate financing, that may ease in the near future. Also, more housing may be built for the rental market, which has grown considerably in recent years. The dynamic is a continuing population growth rate in England and Wales (7 percent in the decade preceding the 2011 census) juxtaposed against a woefully inadequate amount of building to replenish the housing stock. Also, the economics of one town may differ greatly from another, with pockets of growth tied to the fortunes of one or two industries.
The trick is to predict with confidence what the dynamics will be and how it might affect real asset investments. E.g., with built property, commercial and residential, it’s vacancy rates. With undeveloped property, it’s the demand for housing and the political inclination toward encouraging the development of land.
With each of these problems, the seasoned investor – or their investment advisors – will fare best when they apply deep knowledge to the specific type of asset. And just as no two assets are exactly alike, so too are the objectives and portfolios of one investor to the next.
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