|Methods and techniques|
Real assets are assets that have a physical representation and their value comes from their properties and solid presence. In short, that means they can be seen and touched. They are also often being wrongly called “tangible assets”, however there are significant differences between these two definitions.
Real asset components
Real assets include:
- real estate,
- sustainable resources,
- precious metals (gold being the most frequently mentioned example)
The advantages of real asset
The main advantage of real assets in investing is their role in diversifying a portfolio. It is especially important in times of a financial recession, crisis, destabilization, periods of high-inflation, because the fact of having a real representation they fair better than financial assets. For that reason, they are considered much more stable no matter the macroeconomic situation or inflation rate . Real assets also tend to steadily and predictably increase in value which is why vast majority of investors own them as a mean of providing an additional income stream . In times of crisis or financial panic, many investors switch to gold or silver, which is considered as one of the safest assets there are.
Real asset defects
On the other hand, the main drawback of real assets is their relatively low liquidity compared to financial assets . That means they cannot be easily converted to cash in a short time unless losing substantial part of their value. That is the case especially with real assets being owned by businesses, such as buildings or equipment. The reasons for the drop in value are lack of potential buyers and limited time frame (for example when a company faces bankruptcy and needs cash). This is not so much the case with real assets used for generating passive income like gold or silver, however they are still considered less liquid than stocks that require just a couple of hours to sell. What is more, real assets usually have higher transaction fees than financial assets. Another significant disadvantage is the possibility of degradation of real assets with time which would affect their value. Sometimes, they require occasional maintenance or proper storage conditions resulting in additional costs. For example, value of building diminishes due to depreciation - it becomes older and is worth less.
The meaning of real asset
Almost all businesses possess a wide variety of real assets, such as buildings, inventory, equipment, land, etc.. In layman terms, these are properties or rights to properties owned by the firm. Their main role is generating value and income for the company, and maintaining proper cash-flow. They are used for main operations, for example production processes. For instance, factory would be a fixed asset - a kind of a real asset, and raw materials used to produce the goods - being current assets - are also considered as real assets. The ratio of those assets will show the firm asset structure. Companies should own a combination of real and financial assets to maintain a correct asset structure, healthy condition and proper business model. Of course the asset structure would vary greatly between branches or company models.
It is important to point out that stocks and bonds are not real assets. These fill into the separate and distinct category of financial assets. Stocks get their value from a claim on other assets, either having physical representation or not. However, their valuation is similar to that of real assets - it is based on their ability and potential to generate cash flows.
Also, the division between tangible and intangible is a separate one and does not overlap with the real vs. financial differentiation, which can often be misleading. Tangible assets, besides real assets, also include stocks, bonds, property, cash etc. Basically, these are real assets and financial assets combined. Intangible assets contain trademarks, copyrights, brand names, webpages, patents, company’s good-will and similar items. Tangible and intangible items appear on company’s balance sheet which can be used by investors to determine value of the company.
- Michael, S., Arjun, C., & James, W. (2001). Real asset ownership and the risk and return to stockholders. Journal of Real Estate Research, 22(1-2), 199-212.
- Parajuli & R., Chang, S., J. (2015). Real Assets and Inflation: Which Real Assets Hedge Inflation? Conference: AAEA &WAEA Annual Meeting
- Cremers M., (2013). The Performance of Direct Investments in Real Assets: Natural Resources. Infrastructure and Commercial Real Estate
- Ang, A. (2013). IncIlliquid Asset Investing, Columbia Business School Research Paper, 13-2
- Parajuli & R., Chang, S., J. (2015).
- Cremers M., (2013).
- Ang, A. (2013).
Author: Klaudia Trybuła