Real Assets Definition
Real Assets are tangible assets that have an inherent value due to their physical attributes, and examples include metals, commodities, land, and factory, building, and infrastructure assets. They 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. 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.
Assets may be categorized into various classes as real, financial, etc. 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 it can be traded for cash and hence are deemed to be assets. Intangible assets do not have a physical form like brand, patents, trademarks but a brand holds value to any business entity as it brings in patronage in the form of customers and adds 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., which may be termed as 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.
Example of Real Assets
For example, a company owns real estate properties, the fleet of vehicles, and office buildings are real assets. However, it is a brand name that is not a real asset, even if it has a market value. From an investor’s point of view, real assets are assets that provide hedging against inflation, currency value fluctuation, and other macroeconomic factors.
Real Asset vs. Financial Asset
Financial assets include stocks, bonds, and cash, while real assets are real estate, infrastructure, and commodities. Assets are the backbone and lifeblood of the economy, enabling us to create wealth.
- 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.
- Real Assets, on the other hand, are value-driven physical assets that a company owns. They include land, buildings, motor car, or commodities. The unique feature of it is that they have intrinsic value by itself and don’t rely on exchanges in order 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 real assets are less liquid than financial assets since real assets 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.
- Real assets have the advantage of stability as compared to financial assets. Inflation, currency valuation, macro-economic factors have more bearing on financial 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 assets market is complete with inefficiencies. There is a lack of knowledge that makes the potential for profit high.
- It can be leveraged wherein real 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 real assets like land, plant, and real estate projects provide sound and steady income streams to the investors.
- It has high transaction costs. When we buy shares 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 may be difficult 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.
- On the sale of real assets at a higher price, capital gains tax is applicable. A property sold within three years of purchase will be subject to short term capital gains tax, but if sold after three years, long term capital gains tax is applicable.
- The capital asset to be bought requires high capital investment. Because of high capital costs buying and selling it becomes a challenge. This is the reason people generally rely on borrowed funds to buy real assets.
- They also have higher maintenance costs than other forms of assets. The investment in it 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.
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 real 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.
This has been a guide to Real Assets and its definition. Here we discuss an example of real assets along with advantages, disadvantages, and differences from the financial asset. You can learn more about from the following articles –