Investments can generally lead to profit in three ways: capital appreciation, increasing income or decreasing expenses. In the long run, average real estate prices have moved almost in lockstep with inflation, implying that the potential for long-term capital gains on real estate is not very large. Sure, many of the highly destructive real estate bubbles which have been building and popping across the world over the past decade or so have given the opportunity for large short-term capital gains, but, as discussed in the previous post, participating in such debt-driven manias is highly unethical.
No, real estate investments primarily bring profit through the income streams they generate. This includes all real estate which people have to rent to fulfill some particular function – things like office blocks, shopping malls, hotels and apartment buildings. If you own a share in this kind of productive real estate, you are entitled to a share of the income stream generated.
In some cases, real estate can also decrease expenditures. A good example is spending money to make your home more energy efficient through insulation or even to make your home completely energy independent through renewable energy micro-generation using solar panels or wind-turbines. In this way, you can simultaneously increase the value of your home and save money on utilities every month. We will talk a lot about these options in a later chapter.
In practice, non-professional investors should see real estate very similarly to stocks by simply investing in professionally managed funds or real estate investment trusts. Historically, real estate has moved quite similarly to the stock market and the guidelines given in previous posts on the stock market in developed, developing and frontier economies therefore also apply to real estate investments. However, real estate returns are by no means fixed to stock market returns and it is therefore highly recommended that you also diversify into some real estate funds in order to further diversify your holdings in real assets.
Finally, I would just like to emphasize once more on the importance of resisting the great temptation of using leverage when it comes to real estate. Yes, the use of leverage can greatly enhance short-term capital gains, but it always does long-term damage to the economy through large malinvestments, great distortions in the labor market, excessive debt and unethical wealth transfers. This greedy rush to unearned wealth is perhaps the primary reason for the economic mess we find ourselves in today. Please do not allow greed to overshadow your morality.