What Are Real Assets?
Real Assets are tangible assets that have an inherent value due to their physical attributes, and examples include metals, commodities, land, factory, building, and infrastructure assets. They are appealing to the investors as they provide good returns, hedge against inflation, lower covariance with equity investments, and tax benefits as they can claim depreciation on assets.
Real assets add to the investor’s portfolio value by maximizing returns and diversifying risks as they have lower covariance with other financial asset classes like shares and debt bonds. It is the physical nature and characteristics of the underlying assets that determine the value of these assets.
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Real Assets Explained
Real assets are one of categories in which assets exist, the other two being the financial assets and intangible ones. It provides a steady and stable income to its investors, maximizing returns and diversifying risks, which in many ways balances the portfolio of investors as these assets have a negative correlation with other assets. But it requires huge capital investmentsCapital InvestmentsCapital Investment refers to any investments made into the business with the objective of enhancing the operations. It could be long term acquisition by the business such as real estates, machinery, industries, etc. and other risks as well.
Financial assets are liquid assets that hold value through ownership rights in the paid-up capital of any company. They hold some intrinsic value to a company or retail investorRetail InvestorA retail investor is a non-professional individual investor who tends to invest a small sum in the equities, bonds, mutual funds, exchange-traded funds, and other baskets of securities. They often take the services of online or traditional brokerage firms or advisors for investment decision-making. as they can be traded for cash and hence are deemed assets. Intangible assets do not have a physical form like brands, patents, or trademarks. Still, a brand holds value to any business entity as it brings in patronage in the form of customers and addsIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company's net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company's net identifiable assets from the total purchase price. goodwillGoodwillIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company's net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company's net identifiable assets from the total purchase price. to a business because of the brand identity through which it identifies itself in the market and sets it apart from others in the market. Financial assetsFinancial AssetsFinancial assets are investment assets whose value derives from a contractual claim on what they represent. These are liquid assets because the economic resources or ownership can be converted into a valuable asset such as cash. are liquid assetsLiquid AssetsLiquid Assets are the business assets that can be converted into cash within a short period, such as cash, marketable securities, and money market instruments. They are recorded on the asset side of the company's balance sheet. that hold value through ownership right in the paid-up capital of any company.
Stocks, Long term debt bondsLong Term Debt BondsLong-term debt is the debt taken by the company that gets due or is payable after one year on the date of the balance sheet. It is recorded on the liabilities side of the company's balance sheet as the non-current liability., bank deposits, or cash are classic examples of financial assets. Most companies hold a mix of tangible and financial assets. For example, a company may own a motor car, factory land, and building. However, it may also have certain intangible assetsCertain Intangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can't touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. like patents, trademarks, and intellectual property rights. Lastly, the company may have investments in its subsidiary companiesSubsidiary CompaniesA subsidiary company is controlled by another company, better known as a parent or holding company. The control is exerted through ownership of more than 50% of the voting stock of the subsidiary. Subsidiaries are either set up or acquired by the controlling company., termed financial assets. Stocks, Long term debt bonds, bank deposits, or cash are classic examples of financial assets. A mix of assets provides a good hedge against market risksMarket RisksMarket risk is the risk that an investor faces due to the decrease in the market value of a financial product that affects the whole market and is not limited to a particular economic commodity. It is often called systematic risk. as physical assets move in the opposite direction than financial assets. Real assets provide more stability but less liquidity as compared to financial assets.
Real assets are properties that are tangible, i.e., can be touched, have longevity, involve high transaction cost, and acquire a physical location. The assets that exhibit these characteristics are categorized as real property. Listed below are some of the types of such assets. Let us have a quick look at the classification:
When one owns a land, it is considered a significant tangible asset. This can either be used to build one’s own residential or commercial structure or building or it could be sold to real estate developers to earn a lump sum at once. Homeowners can also have their own house developed on the land, which they may put on rent for a regular cash inflow. They have longer lifespan and in case of damages, there is an option of renovation or repairs to increase longevity.
The next on the list is the architectural developments that are initiated from time to time. Beginning from public facilities to transports, every single structure that is built is a real tangible asset. Though it involves a lot expenditure initially, they help in acquiring intangible assets in favor, including goodwill and improved reputation.
Collecting antiques, art pieces, and vintage items is yet another type of real property. These collectibles can be sold to authorities that want to preserve such items in museums or share at exhibitions. In return, the owners get a chance to earn significant cash flow.
Natural resources, which seem to decline in quantity in the future, are the next types of tangible assets on the list. These include energy resources, minerals, etc. These help in capital appreciation and let investors hedge against inflation whenever required.
Let us consider the following instances to understand the real assets definition better:
A company owns real estate properties, and the fleet of vehicles and office buildings are real properties. However, it is a brand name that is not a physical asset, even if it has a market value. For investors, these assets become elements that provide hedging against inflation, currency value fluctuation, and other macroeconomic factors.
On October 3, 2023, a report claimed that the market is about to witness a turmoil. Bank of America’s chief investment strategist Michael Hartness advised individuals and entities to stay more in real assets than financial assets as the former would be more dependable in the market trauma that is about to hit the US dollar. He came to the above calculation after observing how the government is spending high and making monetary policies more accommodative. He specified that the current spending is even lower than the level maintained during the COVID-19 pandemic. He added that the levels of spending are similar to what was witness during the 2008 financial crisis.
Real assets are assets that exist in physical form and help investors earn significantly whenever they invest in them. This is what make these assets preferable in the market over other forms of assets. Let us have a look at some of the vital benefits that these assets bring to the table:
- These assets have the advantage of stability as compared to financial assets. Inflation, currency valuation, and macro-economic factors have more bearing on finances than real.
- It has a strong negative correlation with financial marketsFinancial MarketsThe term "financial market" refers to the marketplace where activities such as the creation and trading of various financial assets such as bonds, stocks, commodities, currencies, and derivatives take place. It provides a platform for sellers and buyers to interact and trade at a price determined by market forces..
- They are not dependent on financial market volatility. It is a profitable investment alternative for risk diversification and offers profitability, not related to or dependent on financial markets.
- They are a good hedge against inflation. When inflation is high, asset prices go up.
- Unlike the capital marketCapital MarketA capital market is a place where buyers and sellers interact and trade financial securities such as debentures, stocks, debt instruments, bonds, and derivative instruments such as futures, options, swaps, and exchange-traded funds (ETFs). There are two kinds of markets: primary markets and secondary markets., the real asset market is complete with inefficiencies. There is a lack of knowledge that makes the potential for profit high.
- It can be leveraged wherein real physical assets can be bought with debt.
- Cash flowCash FlowCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. from physical assets like land, plant, and real estate projects provides the investors with sound and steady income streams.
Despite having multiple merits, there are some aspects, which when considered restrict individuals and entities from investing in them. Below are some of the points that clearly state the demerits of these asset types. Let us have a look at them:
- It has high transaction costs. When we buy sharesBuy SharesKnowing how to buy shares is crucial for a person who wants exposure to the equity market. Equity markets are volatile, and timing is very important. Shares trade in exchanges, but you just can’t go and buy a share from the exchange. There are several steps involved in purchasing a share. or stocks, the transaction costs are lower. But when buying it, the transaction costs are relatively high. The transaction costs can affect the value of investments, and it may not be easy to make a profit. It has low liquidity.
- Unlike financial assets that can be traded within a few seconds, these assets are comparatively less liquid as land and building capital assets can’t be easily traded without significant loss in value.
- Capital gains tax is applicable on the sale of real physical assets at a higher price. A property sold within three years of purchase will be subject to short-term capital gains tax, but long-term capital gains tax is applicable if sold after three years.
- The capital asset to be bought requires high capital investment. Because of high capital costs buying and selling it becomes a challenge. It is why people generally rely on borrowed funds to buy real tangible assets.
- They also have higher maintenance costs than other forms of assets. The real assets investment is illiquidIlliquidIlliquid refers to an asset that cannot be converted to cash. Such assets suffer a valuation loss when sold in exchange for cash. Bonds, stocks and properties are some examples of illiquid investment. and locks up a huge sum of capital, which is difficult to redeem.
Real Assets vs Financial Asset
Financial assets include stocks, bonds, and cash, while real ones are real estate, infrastructure, and commodities. Assets are the backbone and lifeblood of the economy, enabling us to create wealth.
Let us check out the difference between real assets and financial assets below:
- Financial Assets are highly liquid assets that are either in cash or can be fast converted to cash. They include investments such as stocks and bonds. The major feature of financial assets is that it has some economic value that is easily realized. However, by itself, it has lesser intrinsic value.
- On the other hand, real physical assets are value-driven physical assets that a company owns. They include land, buildings, motor cars, or commodities. Its unique feature is that they have intrinsic value by themselves and don’t rely on exchanges to have value.
The similarities between real and financial assets are that their valuation depends on their cash flow generation potential.
The difference between them is that the real ones are less liquid than financial assets since the former are difficult to trade, and they don’t have a competitive and efficient exchange. They are more location-dependent, whereas financial assets are more mobile, making them independent of their location.
This has been a guide to what are Real Assets. Here, we explain the concept along with vs financial assets, examples, types, advantages, and disadvantages. You can learn more about it from the following articles –