Planning to invest in real estate? Don't do it until you read this.

The lack of financial literacy may prompt people to consider investing in real estate. This is a provocative statement, so let me explain why.

When considering finances, there are three aspects:

• How much do you earn and how stable is your income?
• how to control your expenses,
• How to plan future expenses, including retirement.

The younger you are, the more you should invest in yourself, such as education, training, expanding your network, etc. As you age, you should start saving money for retirement and major expenses, like buying a car or a house. A suitable time for investing in real estate is the period before retirement, when it's important for you to be able to generate income from your investments and mitigate potential losses, as you have less time to recover.

In what case are real estate investments worth considering at all? Real estate is an illiquid asset with high management and operational costs, and if you plan to use credit to purchase it, there is a risk of instability in the lending market, i.e., fluctuations in interest rates. Thus, it is not suitable for older people approaching retirement age or for those just starting their careers who need to focus their money, time, and attention on education and expanding their network (which also means flexibility in choosing a place to live).

People in the age group of 35 to 45 years (and even from 30 to 55) can consider investing in real estate only if they have utilized all the tax benefits provided by the government for retirement savings (which is essentially free money), have significant savings in international stocks and bonds, and also have an emergency fund equivalent to 6-12 months of expenses. If they meet the above criteria, they may consider real estate as an investment option, provided that this investment does not exceed 10-15% of the total value of their portfolio (this ratio is used by pension funds and social security funds, etc.).

But which property to choose? Not a one-bedroom or a two-bedroom apartment! No. No. No. Investing in real estate through a fund traded on the stock exchange (ETF) provides the owner with liquidity, diversification, and less time spent managing investments.

An ETF is a type of investment fund that is traded on stock exchanges, similar to individual stocks. It includes various types of real estate, such as residential, office, shopping centers, etc., which are professionally managed and can be bought or sold through a brokerage account.

Let's consider the concepts of "liquidity" and "the ability to choose a winner." At what stage does the liquidity problem become a solvency issue? The liquidity problem in real estate investments refers to the difficulty of quickly selling assets with minimal discount. For example, if an investor needs to sell a property quickly but the real estate market is slow, they may have to sell at a lower price than expected.

On the other hand, the issue of solvency refers to an investor's inability to meet their long-term financial obligations, such as repaying debt or securing a pension. For example, if an investor took out a mortgage to purchase property and the value of that property significantly decreases, the investor may find themselves owing more on the mortgage than the property is worth. In this case, the investor may struggle to sell the property and pay off the mortgage, ultimately leading to the risk of default or foreclosure.

Does this remind you of what has been happening since 2008 in Southeast Europe? Most people approaching the "real estate investment age," i.e., 30-35 years old, do not have such memories, as they were in school or university during the Great Financial Crisis (GFC). Current examples include the freezing of withdrawals from some of the largest real estate funds, such as Blackstone's BREIT (with a volume of $69 billion), and a (humorous) reference in the 2022 presentation of the Norwegian sovereign fund, which noted that the value of real estate in funds traded on the stock market had decreased by 31%, while the value of some unaccounted properties (whose value is based on appraisers' opinions) remained stable.

What about your ability to choose a "winner" thanks to your connections and deep knowledge? In 2008, Warren Buffett made a $1 million bet against the best hedge funds on Wall Street. He wagered that over 10 years, a regular index fund would outperform the top hedge funds. The results were astonishing: Buffett's ordinary stock fund had an average return of 7.1%, while the hedge fund portfolio only yielded 2.2% after fees. Buffett won the bet and donated his winnings to a nonprofit organization. He advised both large and small investors to stick with low-cost index funds, stating that when trillions of dollars are managed with high fees, managers usually profit. Standard & Poor's tracks the performance of active managers and found that 84% of them perform worse than what would be expected by chance after 5 years, and 90% after 10 years. Meanwhile, high fees are still charged despite poor performance.

Direct investments in real estate are wonderful! You can see and feel your investment, obtain financing for it, earn rental income, and then sell it when prices are high. At the same time, it limits your flexibility, requires significant management costs, is subject to high taxes, and is unlikely to outperform simpler and more liquid options. But no one listens to this advice. That doesn't stop me from giving it.