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Why I Dislike Real Estate as an Investment
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There are two parts to any investment – cash flow and equity appreciation. Cash flow refers to how much money the investment generates and equity appreciation is how much the investment itself grows in value. When you look at real estate, cash flow refers to any rents you can earn and equity appreciation refers to any increase, or decrease, in the property’s value.
In the last few years, real estate has taken a huge hit because prices simply grew too quickly, financially incapable people were given loans they couldn’t afford, and the myth that “buying a home is the best investment ever” was finally revealed to be the result of incredible anecdotes and not a statistical look at historical home values.
I’ve never liked the idea of real estate as purely an investment for a variety of reasons.
Diversification
Part of the reason probably has to do with our age and our current nest egg. We have already invested close to $300,000 in real estate with our primary home, that we purchased three years ago for $295,000. When you compare that with our retirement and taxable brokerage accounts, our home already represents a significantly portion of our investment allocation.
To go out and buy another piece of property for the purposes of making it an investment would really put our allocation out of whack. That’s the number one reason why investing in real estate is not appealing to me.
Significant Minimum Investments
You can open a Vanguard account, invest it in their STAR fund, for $1,000. Can you buy a piece of property with only $1,000?
When you invest it in a mutual fund, your liability is limited to $1,000. When you buy property, you’re on the hook for a lot more… even if it only requires a $1,000 down payment. Someone could get hurt on your property, it could burn down or be flooded, or it could seized by the government under eminent domain. Insurance will cover against most of those issues but insurance costs money… which leads up to the next reason.
Holding Costs
When you own property, there are significant holding costs involved. You have to pay property taxes, insurance, interest on the mortgage, local and county taxes, utility costs like electricity and water, and that’s outside of any management fees. When you purchase a home, not only are you getting the liability of the mortgage but also all the weight of monthly carrying costs.
If you’ve ever watched a flipping show on those home improvement channels, you’ll know what kind of pressure these holding costs can have. First time flippers almost never finish their projects on time and see those monthly holding costs cut into their profits. These holding costs will eat into your cash flow or your equity appreciation.
Transaction Costs & Time
When you sell a home, you pay 3% to the seller agent and 3% to the buyer’s agent. So you lose 6% of the total value of your property to the transaction. That also doesn’t include any last minute touch-ups to the house that you may need to make, such as a fresh coat of paint or staging fees to make your house look better.
When you get to the time involved, that’s where it really gets serious. How long does it take for a house to sell these days? If you’re lucky, a couple weeks. If you’re not, it could take a year or two. How will the market be in a year or five? Will it be sizzling hot like five years ago or will it be like today? If you need the money for something, you could find yourself taking a hit just to liquidate quickly.
Stock market? Stocks will trade in seconds (minutes if it’s lightly traded) and it’ll cost you less than ten bucks.
Am I Advocating the Stock Market?
In a way, yes I am. It’s liquid, there are little to no holding costs, and the transaction costs are low. It’s just as difficult an investment arena to understand but the system is a lot easier to manage. For individuals at my age, 20s and 30s, I think real estate is a fools errand and the stock market offers the flexibility we need.
If you already have a lot invested in the stock market, perhaps real estate is the way to go. It’s just not the sure thing people always make it out to be. When your friends tell those stories about how someone sold a house they bought in the 80s for $50,000 and sold it for $500,000, ask them how much was paid in interest, property taxes, and real estate agent commissions.. then think about whether a similar investment in the stock market might have yielded similar or better results. 
What are your thoughts about real estate as an investment? I know it is a very popular subject so I’m eager to hear your thoughts!
(Photo: lcd1863)
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Two thoughts:
a.) You can reduce the bite-size and the asset concentration/allocation issue by partnering with someone you truly trust (sibling, cousin etc) – that way you could invest a smaller amount of money. I have seen this model succeed, but also fail in a gruesome way – it really depends on trust, reliability and having the same goals / patience.
b.) You can get the best of real estate and the stock market by investing in REITs. However, I have never taken the time to research them and understand them well enough to invest – thoughts on those Jim?
What about REITs? You can trade them like stocks, but they’re backed by real estate when you pull back the curtain. They’re pretty volatile, but you get around a lot of the disadvantages that you outline.
I tend to agree with you Jim. I think of purchasing real estate as buying a place to live, not as an investment. I invest in real estate by buying a REIT.
Isn’t the minimum for the Vanguard STAR fund $1000 and not $3000?
Whoops, you’re correct, my memory failed me.
I agree with you in general. Buying a home is an expense, not an investment – and a home loan guarantees the greatest possible expense. The stock market is mainstream gambling, but at least you know exactly what you stand to lose. As far as I can see, some legitimate reasons to purchase a home are to live in it, leave it to heirs, not have people stomping over your head upstairs in an apartment or stealing your parking spot, and to enjoy some psychological effect from having territory you consider your own. As someone who has rented for many years and is now considering purchasing a home, I easily concluded that even with a home free of a mortgage payment, our expenses will at least equal paying rent and utilities in our current apartment – and could exceed the costs by up to $500 monthly.
This is a tough economy for a real estate and equally as tough for the securities market.
I have a client (and good friend) who started forty years ago as a bank teller earning $80 per week. He left that and became a real estate salesperson, then a broker, then in the earliest stages began to buy and sell on his own account. Now he’s a serious multimillionaire. Has been for two decades. Through the years there has been some flipping, some foreclosure purchases, some multi-unit apartments, and hundreds of rental houses.
I asked him the other day given this economy whether he would do it again or do something else and he said “Absolutely do it the same way.” I asked why and he said “it’s the simplest reason that gets people involved in rental property in the first place. You buy property and someone else pays for it. Even if you end up selling for $.50 on the dollar, that’s $.50 someone else paid for you.”
My sentiments exactly! The cost of holding real estate eats away at any apprecication one can expect. My back of the envelope is that it costs about $20,000 a year to hold a vacation home, not including the mortgate payment. Utilities, property taxes, insurance, homeowners association fees, upkeep and maintenance…it all adds up.
Buying a home is not an investment, for all the reasons you listed. However, buying and holding investment real estate can definitely be an incredible investment, even with regard for the things you mentioned. Here’s my response to your reasons:
Diversification – “Diversification is a protection against ignorance. It makes very little sense for those who know what they are doing.” – Warren Buffett. On the other hand, when you have tv shows about the average joe blow flipping houses, it’s not surprising to see the financial carnage that ensues.
Minimum investment – True, but not a bad thing. Having a large chunk of money in a business you own is a good motivation to keep it in good financial shape.
Holding and transaction costs – Every investment has some holding cost. Just like any other type of investment, returns should be calculated after including *all* expenses, including tx and holding expenses.
You’re definitely right that real estate is not a sure thing, but it offers a few major advantages:
1. Leverage – Two way street but incredible for those that use it well.
2. Tax advantages
3. Tangible asset very unlikely to lose all value (though because of leverage, it doesn’t have to in order to wipe you out)
There are others, but you get the idea. Investing in the stock market is a lousy way to build wealth. Sorry, but it’s the truth. Look at all the self-made millionaires and billionaires out there. Almost all of them made their money through owning their own company or real estate (a type of owning your own company).
Phenomenally thoughtful response and I agree with your argument that it can be a good investment, but is it better than more flexible alternatives? I think one problem people run into with real estate is that everyone thinks they’re an expert when in reality they probably aren’t (average joe blow flipping houses, they’re never going to do it right the first time and how many times will the novice investor buy and sell homes?).
It is a tangible asset that’s unlikely to lose all value but, as we’ve seen the last few years, people are known to overpay and so homes can lose some of their value. It doesn’t take much % loss for it to hurt, 1% on a $200,000 home is still a solid two thousand bucks. It won’t cripple you, but dang it’s going to hurt.
Jim,
As a rental real estate owner for 6 years I can say that Ryan is right…
1) The fundamental question surrounds balancing the expected ROI after all income and expenses with the risk factor of the investment. Our rental property is worth a net $150K after all fees and taxes on a sale…
Each year, we earn a net $7,500 in income after taxes on the property. That means our ROI is 5% after taxes (equivalent to about a 7% before-tax ROI). That does not take into account any appreciation of the property (we bought in 2001, so we made out well).
We do not have a mortgage – if we did we could make the ROI number come out to 20-30%, but we’d be leveraged and we prefer to be in a debt-free position right now.
2) Rental real estate offers very high tax incentives because you can deduct the mortgage interest and the depreciation on the improvements (not the land). You have to recapture depreciation on a sale but it is limited to 28% or your marginal tax bracket, whichever is less.
3) If you find the right kind of renters (this is **KEY**), you have very little hassle and the rent gets paid on time each month. Credit checks and reference checks are essential.
4) Real property is easy for banks to understand and thus easy to obtain financing for — this allows the ‘average joe’ to take on secured business debt with only 20% down.
You simply can’t find that kind of loan for other types of investments, which means you can’t get your hands on the money to increase your leverage and ROI, even if you wanted to.
5) Expenses for personal property and investment property are treated differently for tax purposes (for instance, there is no mortgage deduction phaseout for investment property for high income earners)… and everything is deductible on rentals (insurance, interest, mortgage insurance, repairs, improvements (via depreciation), marketing, etc), as opposed to just the mortgage interest on personal homes.
6) Personal real property is basically an expense, not an asset (or investment). Once you set a standard of living by buying a particular house, few people are willing to lower that standard until very late in their life – potentially downsizing for retirement. In order to get the “equity” everyone talks about out of your housing “investment,” you have to downsize. It is better than renting, of course, but it isn’t the type of ‘investment’ that any business person would take.
You seem to be mostly talking about flipping houses. I personally don’t think flipping houses is a good idea for the vast majority of people. THeres too much risk there and you have to know what you’re doing to make a profit. Owning rentals is a very different kind of investment and I think its a much better choice for most people. Using your home as an investment is also a different matter. Your home is a place to live, not a cash cow.
I think that real estate can be a very good investment but its not for everyone.
On the down side: Real estate is illiquid so its hard to get to your asset fast and it might not sell for months. The amount of WORK involved in direct real estate ownership is a major issue. Its a LOT easier to simply buy a REIT index fund.
I think Ryan makes some great points – especially,
“Look at all the self-made millionaires and billionaires out there. Almost all of them made their money through owning their own company or real estate (a type of owning your own company).”
Your primary residence is NOT an investment. So, your investment in real estate is 0%.
My answer would be it depends. I would not include most peoples houses as a investment because they honestly are rarely bought as a true one. If you buy a duplex or a rent out rooms in your first house, thats a investment. Simply living there is at best a way to lower costs, worse a unneeded liability.
I would however look at it as a quasi investment. Its not like a stocks and mutual funds were you don’t have involvement with the actual value of the investment. With Property you have to invest time like it is a business. If you lose money, its usually because you made bad business decisions.
As a investment I think its fine as long as you are willing to put the work in. If your not you will lose your money. I think there is greater potential for profit in real estate, however it comes with increased risk and work.
Jim, I agree with you completely. A big part of the reason for the real estate flame out of the past few years has been the shift in the view of housing from a home to an investment. There are all kinds of implications there.
I think most people think real estate investing is easier than it really is. I come from a long line of real estate investors, and you have to view it as a business, not as an investment.
A mutual fund or CD don’t spring a leak in their plumbing in the middle of the night requiring you to get out of bed and deal with the problem. And it’s a LONG term investment, not a place for short term, get rich quick trades. You’re completely dependent on the direction of the market and on the state of the rental market.
Unless you have the time and the stomach, real estate investment is best left to those who do. It’s far messier than most people realize.
Jim, is that the House of Seven Gables in the photo???
It is. Interesting choice for this article, huh?
Completely agree. A house is more a liability than an investment.
If you live in DC where housing is supposed to be “recession-proof”, and it seems to be in the older well-established neighborhoods, then RE is an excellent investment. You will have demand from govies, IMF/World Bank types, they pay your mortgage and your equity grows. It’s a long-term wealth making strategy.
This has got to be the most detailed article I have come across against investing in real estate. You make very valid points. I’m not in a position to do much investing at all right now, but real estate, while seemingly desirable, has been a turn-off mainly due to the maintenance required. I don’t want to worry about the upkeep of a house and tenants. Undeveloped land on the other hand… maybe. They are not making any more of it.
I used to like real estate, until I lost money. The same with stocks. Now I get hardly any interest on savings. Is it better to just pay ahead on fixed expenses and go on a lot of vacations? What is safe and has a guaranteed decent return? Nothing I can see.
John DeFlumeri Jr
“What is safe and has a guaranteed decent return?”
Treasuries (and even that may be too risky for some). Aside from that, nothing. The reality of investing is that it’s hard work and you have to be able to stomach risk. If you can’t, kiss your dreams of building wealth goodbye and try to marry into it instead.
John – “Is it better to just pay ahead on fixed expenses and go on a lot of vacations?”
That’s a deep financial philosophy question. You should write a post on this question and invite opinions. Could make for a most interesting debate.
Jim, from your perspective I’d have to agree. I actually would love to be a RE investor one day, but it works best when you are in a position of strength. That means having little or no mortgage on your rental properties to maximize cashflow, a sizeable emergency fund to access in case a roof needs repaired or something, AND all this should be balanced by a sizeable nest egg invested in mutual funds. In other words, I’d have to be debt free and pulling down tons of dough each month that I can save up to buy properties every year or two.
Great points Jim!
“That means having little or no mortgage on your rental properties to maximize cashflow”
If you do this, there’s almost no point in investing in real estate, as you give up leverage and get a terrible ROI and ROE. That said, it’s important not to be over-leveraged, either, but avoiding debt altogether is foolish.
Thank for posting and stirring the discussion! My 3 points:
1) Your home is not an investment indeed. Proof is that the bigger it is the more it will cost you rather than generating income streams. I recommend Rich Dad, Poor Dad on subject if interested.
2) Leverage is a huge advantage in real estate. You can buy an appartment of say 100k with 20k USD in cash thanks to the use of the house as collateral (e.g. mortgage). This allows for benefiting disproportionally from gains/losses while also building up your net asset base (because in say 10 years the rents will have paid your mortgage & you will only get the revenue).
3) Regarding the cost of real estate, it should be costed in the investment. The stock market is easier (if I may say…) because you have only 4 data points beyond market itself (buy price, sell price, taxes, fees) but the same financial rigour can be applied to real estate when buying for rent (taxes, ownership costs, selling cost, gross yield of rent, cost of mortgage, net yield, etc.). Some factors will come with luck or pain which is part of the market and pleasure of this business (bad renter, issue with walls, area goes up in value, etc.) but it can be made more rational if you want to.
Net, I think that real estate is very attractive because allowing building a solid personal asset base on the long run thanks to leverage. Yet I would agree that it is a question of taste too given the specific parameters involved in this kind of investment.
I recommend staying away from Rich Dad as far as you can. Some nuggets of truth in there but so much more that people can misunderstand and take them off the right track. Look here for more details:
http://www.johntreed.com/Kiyosaki.html
I think whether or not real estate is attractive is driven by relative valuations.
In most parts of semi-rural or suburban US you can buy a condo, house, living unit for about 10-12 annual rents (purchase price = 10-12 * 12 * monthly rent). In and around bigger cities however, that multiple is inflated, often up 20-25 annual rents. I.e. compared to local rents, buying a place in some locations is much more expensive.
The reason for the difference is that 10-12 multiple value derives most its value from future cash flow of a rental property. But for the 20-25 multiple properties, more than half of the value is driven by future appreciation expectations. Comparing it to the stock market, the lower multiple are classic dividend producing stocks whereas the high multiple stocks are typical high growth stocks.
So far, so good.
But what if you want to *invest* in real estate, e.g. by buying a rental property?
I personally find a low multiple income focused property much more attractive, than one that is nearly double the relative price because of high growth hopes for the future. I want to invest in the cash flow, not bet on future appreciation. But that is what many people do when they buy rental properties in expensive locations.
Unfortunately, I live in such an expensive city and for this reason don’t want to invest here. I would actually like to invest in a low multiple area, but that is too far away for me to manage effectively.
Jim, while I agree that your own home is an expense and not an investment, I disagree that real estate itself is a bad investment. A couple huge advantages have been pointed out already, especially that of the possibility of using leverage when buying real estate. Your article asks if you can buy a piece of propety for $1,000…the answer is that yes in fact you can. I am buying property with NONE of my own money, which means I have an infinite return on investment. As far as the monthly expenses, if you buy in a cash flow market you can have a very nice monthly return coming in.
It all comes down to whether your real estate you are buying is an asset and putting money in your pocket, or a liability and taking money out of your pocket. Too many people think negatively of real estate because they think that they have made an investment in an asset, when in reality they have bought a liability that they are speculating will go up in value. That’s not true investing anyway.
If your real estate “investment” isn’t cash flow positive from day one, its not an investment. All the people who were banking on appreciation to make their real estate investments pay off are realizing this now. In the long term, real estate doesn’t appreciate at all, it just goes up at the rate of inflation.
And I also hope the term “buying a home as an investment” dies off soon. A home is something you live in, not an investment.
I’m a cashflow investor myself, but your statement is ridiculous. Investing for cash flow is not the only way to invest in real estate. And while the net rate of appreciation across all real estate might be inflation (debatable), there’s definitely huge variance by location, property type, etc. Is it more speculative? Absolutely. But all investment is speculative to some degree.
Jim, I have to disagree on this one. When you invest $1000 dollars in stocks, your ROI is based on $1000 dollars of your own money. So if you realized a $500 dollar return your ROI is 50%. On the other hand, if you had borrowed $500 and invested $500 you ROI would be 100%. Investing in stocks requires the investor to fund the full amount of the investment, while real estate allows you to only lock up as little as 5% of your investment price. This allows you to take advantage of leverage.
All investments have a level of risk. People who flip houses are in the same league as investors who lost their life savings investing in tech companies prior to the dot com bust. If you don’t know your investment, it’s just plain gambling. The costs associated with a real estate investment should be a non-factor if you have factored that into your operating costs and still have a cash flowing property from the start.
Finding a cash flowing investment property is no different than reading a financial statement for a company you would buy stock in.
Leverage cuts both ways, so to just tout its benefits is misleading.
As for the costs associated, I agree that they can be a non-factor but renting out a property isn’t as trivial as you make it seem. Between finding renters and maintaining the property, including repairs between renters, there are costs that you may not have properly accounted for. It’s not impossible, but hardly trivial.
Sorry Jim, I think you miss the mark on your article.
Not all real estate is created equal, commercial vs. residential. Different risks. Different barriers to entry. All to often I read about people lumping the two together.
Yes your house can be an investment, albeit not so much in this market, but in an appreciating market if you utilize the 2 in 5 tax rule your gains (up to $500K MFJ) are tax free. Now you just need to find a wife who doesn’t get tied down because she likes the neighborhood.
Also, the tax advantages are too great to pass up… 1031 exchanges, which means you don’t have to pay tax on a single dime of appreciation while you keep trading up. I don’t think you can say the same for Vanguard’s stuff. Last time I checked every gain from a Vanguard 1099-B sale triggers tax – notwithstanding the zero cap gain rate lasting till 2010 for Low AGI’s.
Also depreciation may eat up all your cash flow and even the excess paper losses may be deductible depending on AGI. What a good way to shield w-2 income. Equity buildup and tax breaks all by holding real estate.
I’d rather see you write an article on how to price real estate in a down market instead of throwing out the real estate (commercial or residential) investment segment entirely.
You could give suggestions for different investment levels, such a Duplex, 4plex or small commericial 1k – 5k sq ft building for entry level investors. 5-50 apartment building or 10K – 100k sq ft Commercial for medium investors and so on.
Cheers,
Stonewall
Stonewall, it appears that there are aspects of real estate investing that I just missed (tax advantages, difference between commercial and residential, etc.). In the end, the post was less an indictment on real estate investing as it was some of the reasons why I dislike it as an investment.
Unfortunately, I’m not an expert on real estate investing, my tune would probably be different if I was. And I’m entirely unqualified to write the article you suggest.
While I agree that real estate investing is not for everyone and that many of the points raised against investing in real estate are valid, all other forms of investment also have their own disadvantages/risks as well.
Personally, I invest in real estate for the longer term cash flow and the ability to take advantage of very cheap loans (I can get floating rate loans in Hong Kong at less than 1% pa interest cost). I am not interested in flipping – too hard, too much work, too expensive and there are also negative tax consequenses under our local tax laws.
Although not directed at Jim’s post, there is a lot of recency bias in some of the “real estate is a bad investment” articles and comments which have appeared since the bursting of the housing bubble. As Nathan Rothschild is reputed to have said, the best time to buy is when there is blood on the streets. People who purchased equities in Q12008 when things were looking their worst have done very well since then. US real estate is still getting a lot of bad press and it is hard to find many people who like it – at some point it should prove to be a solid investment again (although I make no claims to know when that will be).
As an aside, the statement that people occasionally make that a house is a liability is magnificently wrong (unless it has been used as a dumping ground for toxic waste). It is an asset and no level of outgoings will change that.
the long term idea about equity building and sense of belonging tips me towards buying a house..
maybe the second half of this year would be great time to start investing in REIT..what say?!?!
I just think too many people believe real estate is the magic key to wealth. You definitely have to know what you’re doing.
My parents bought two rental duplexes and a house for an investment. Helping them with cleaning and repairs each time a renter moved out was enough to make me know for sure that I would definitely never own a rental.
Interesting article Jim, but I’m afraid I am going to have to disagree with this one. If you take the time get a proper real estate education, the knowledge you will receive will help against making poor decisions and can really increase your wealth. The use of private money plus a good knowledge of real estate investing led my boss to become a millionaire in less than 5 years!
My co-worker is investing in stocks now, and is laughing at me because he has made $800 in the past 4 months, but I now have enough to invest in a multi-family, and with my learning and waiting to invest in a building that will give me a certain % COC return, and will have a property management company running the facility, so I won’t have to deal with toilets & tenants. In order to prosper as a real estate investor, you need to run your company like a CEO, not like a landlord. Landlords make landlord money, and CEO’s make CEO money. (LLC is another good way to protect your assets, so if the property DOES for some reason fail, your personal property won’t be at stake)
Sorry if I have come off strong, but I am positive that the system I am following and learning from works, and have seen it in action.
Professional Property management firms take 10% +
on gross rental income. You’d be better off operating on a shoe string on your first property by getting your hands dirty and unclogging toilets and changing light bulbs. I’m sure your boss wasn’t wearing white gloves starting out.
Also banks usually make you sign a personal guarantee on LLCs if they deem you unqualified, which I’m sure every buyer in America is probably unqualified these days.
i looked into taking over a lease instead of renting just so i had some property as an investment, but the property taxes and upkeep, in my mind, would’ve negated any short term gain and probably bankrupt me in the process lol.
It is a lot of work and there is no guarantee it will appreciate let alone stay static in value
Ryan Waggoner,
Of course cash flow is the only way to invest in real estate, banking on appreciation is just speculation like you said. Speculating is not investing and investing is not and never will rely on speculation. For something to be an investment, you need to have legitimate reasoning as to why you are receiving more in value than what your purchase price is. Someones belief that they can unload a property by selling to a bigger fool in a few months is not legitimate reasoning.
Lets do a thought exercise: What is the long term rate that you feel real estate will appreciate at? If this rate is greater than the rate at which workers wages rise, what will happen down the line when you want to sell your property that is “worth” 3X what you paid for it but workers wages have only risen 2X? If no one can afford it, you won’t be getting what you were hoping for.
If you are willing to buy a property that isn’t cash flow positive because you think you can predict the next hot real estate market, you are either speculating or know something that the rest of the market doesn’t know and hasn’t priced in. I can make a pretty good guess as to which of those choices you are relying on.
A lot of people are talking about REITS, but I would put this investment on the same category in the stock category–due to how easy it is to liquidate them. I like the comments that Fred made regarding rental property and I think I would be interested in this type of investment in the future. I am especially interested in a vacation property rental. If anyone has rented a cabin I would love to hear your comments!
I like Fred’s comments and interested in Vacation site property. Does anyone have experience in buying a vacation property and renting (i.e. a cabin in the mountains)?
My 2 cents…
– the profit will come.
1. Your home is your biggest investment. If I put time in something, I am investing. In this case I am putting time + money, you do the math.
2. First and foremost, you are a BUSINESS owner
3. 97% of the world’s wealthiest, their riches came from real estate. With that in mind…
4. Do your homework. It’s no different than the stock market.
- Location, location, location.
- Buy low (search for deals with cash flow, bank owned… & be patient, be realistic),
- Rent smart (run it like a business, outsource the details, too many cleaning & management companies out there. Don’t waste your time, stay in tune with the big picture; real estate),
- Sell high (don’t be greedy, if the profit is far greater than the liability (time + over head) – get rid of it and don’t look back. There is always another deal around the corner). Set a magic number – example: $25k every 10 weeks, you will end up making way more. It’s a number game.
5. Quality sells; quality is king and could be executed without blowing the budget. What you put out is what you bring in.
6. Always remember you are in the business of investing/making money/profit.
7. Define your exit and marketing strategy: example: for a year lease renter, cover their moving expense up to certain amount ($300), for a buyer cover 2 to 3 months mortgage, while you’re at it, add a flat panel TV or their choice of grill, lawn mower, etc…
8. This is the best time to buy – while they’re down, stocks or real estate. What goes up must come down – but remember what goes down must come up too.
9. Do you have passion for real estate? You have to be ready for real estate. It’s not for all…
10. Lastly, don’t forget shelter is a necessity.
11. Enjoy the ride & have fun
What about buying a duplex for a young couple who knows they will stay put? It worked well for us. We bought a house we could afford, had almost 75% of our mortgage subsidized by our tenants and saved the rest.
Ebekele,
I’m not sure where to start…
97% of the worlds wealthiest came frm real estate? Really? How about 97% of statistics are made up on the spot?
Not even worth responding to the rest.
Obviously 97% is an exaggeration, but let’s take a look at the Forbes 400 list (all billionaires). How many of those people made their money in real estate (a lot)? How many many made their money from buying index funds (none)?
I really don’t mind if most people think real estate is a bad investment. The fewer idiots we have driving up prices because they don’t understand basic finance, the better.
Ryan Waggoner,
I really doubt any of the Forbes 400 made their billions buying single family properties and renting them out either…
I’d venture to guess that the vast majority of the Forbes 400 made their money by starting a company with a business model capable of scaling up (Or at least the source of their wealth was such a business in the case of Forbes 400 members who inherited wealth).
If you are aiming to become a billionaire, youd better get your company started. If you are simply looking to invest your money so you will be comfortable in retirement, index funds and yes, cash flow positive real estate investments will do.
Buying a house at the right price is a good investment. You could pay off your mortgage in 15 year or you could keep paying rent for the rest of your life. The choice is simple.
You’re right. When my rent is 1/2 what a mortgage would be in a comp house and I have been shoveling the difference into retirement accounts for years and I have not been paying property taxes or PMI it is a very simple choice.
saladdin
Wow, saladdin, where do you live? Where I am, my rent is such that if I were to spend twice as much on a mortgage payment, I might be finding myself in a mansion!
But seriously, your rent is HALF what a mortgage payment would be for a comparable place? We’re looking at INCREASING the size of the place we are living in through a purchase, and the mortgage payment would only be about 75% of our current rent. I know there are other costs involved in home ownership, but you might want to think about researching other real estate markets. Is relocation an option?
I suppose it’s also possible that you’ve got a RIDICULOUSLY awesome rental situation.
Like everything it is location. I live in The Great State of Tennessee in one of its smaller counties.
I am single and have no use in buying/renting a larger place. I have one room I use solely to store boxes from my internet purchases. If anything I would go smaller.
saladdin
Your rent is half your mortgage, because you are comparing a $100,000 house with a $200,000 house. Renters pay property taxes too. Your LandLord uses your rent check to pay for property taxes.
Ill give you a simple example. If you had $100 grand, you could buy a $100k house and your rent would be Zero dollars every month. 8 percent of $100k is $8k divided by 12 is $666.66 per month. So you save $666.66 of rent money every month and there is a thing called appreciation. An average house appreciates 4 percent every year.
You get 8 percent from not paying rent and 4 percent from home appreciation. So your total rate of return is 12 percent.
12 percent beats your bank CD return of 2 percent any day.
Wrong.
I am comparing same cost houses not a double wide with the White House. I know I am not paying property taxes because I know what the taxes are and what the mortgage payment is versus what I pay. So your math is all wrong.
Blanket statements like “Rent is throwing money away” or “My wife will never sleep with the neighbor” show how little another person can compare their situation to mine.
saladdin
This calculator will help you understand that buying is better than renting.
http://www.nytimes.com/2007/04/10/business/2007_BUYRENT_GRAPHIC.html
Actually, the NYTimes calculator (which is the best I’ve seen) pretty handily convinced me that it wasn’t worth buying in SF because you don’t break even after 30 years. You’d be better off renting.
It varies for every market, though.
I agree mostly with David’s point. Comparing the percentage gain of a 100K house that you buy cash with putting 100K cash into a CD shows that real estate is ahead. This example doesn’t even include leveraging which is a HUGE reason why real estate is a great investment. With 100K you can afford a 250K home easily in most cases (even with the conservative nature of today’s banks) — that gives you 150K of money to gain appreciation on. I understand that can be a 2 edged sword, but disregard the last 4 years because its clearly an outlier based on history. Combine this with the principle your tenants are building for you, the tax incentives (shelters), and depreciation (see: (1/27.5 rule)) and in my opinion it far outweighs the next best option. Leveraging also mitigates the argument that real estate only appreciates with inflation — who cares? If I invest 100K and only gain 4% over 30 years, I’m not happy. If I invest 100K and gain 4% on 500K for 30 years, I’m very happy.
I’m with saladdin on knowing a simple economic choice when you see it, or have it, in our cases. Renting is much more economical. It is an order of magnitude easier to have and save money while renting the place you live in. We do think that now is the best time ever to purchase a home, though, and our ability to do so partly comes from having rented instead of paying high utilities, interest, repairs and maintenance, property taxes etc. Yes, we do have a good renting situation as far as cost, and the utilities alone could well equal our rent in the home we are considering. And it is no mansion; it’s under 1900 square feet.
i’m with saladdin and yana.
everyone has a different situation, but renting is way better.
a friend of mine thinks i should buy a house and then have my current roommate help me pay off the mortgage. no friggin way.
so many costs associated with being a homeowner. moreover, real estate in this area (sacramento, ca) isn’t a good gamble right now.
David,
“The average house appreciates 4% every year”.
What planet have you been living on?
He’s right.
http://michaelbluejay.com/house/appreciation.html
Of course, it’s pretty much inflation, though I’ve seen studies that said appreciation tends to be 1% after inflation is taken into account.
You get 2 percent from inflation (because of the gov printing trillions of dollars out of thin air to bail out companies like aig) and 2 percent from real appreciation(population growth).
The S&P500 went down -38.49 percent in 2008 that doesn’t mean every year the stock market tanks 38 percent, but over the long run the stock market has returned an average rate of 8 percent.
Now let me give you some mathematical proof of home appreciation rates.
The data below is from the Census Bureau.
http://www.census.gov/const/uspricemon.pdf
Use the calculator below to find the average appreciation rate and you will see that you get over 4 percent.
http://cgi.money.cnn.com/tools/returnrate/returnrate.jsp
Ryan Waggoner,
Um, go back to my first post on this thread where I said real estate only appreciates at the rate of inflation and you called me ridiculous for suggesting cash flow investing was the only way to invest in real estate. Now you are bringing up an article that supports my position 100% and contradicts yourself?
David,
Read your quote again David, notice the key words “every year”. It would be like me taking your numbers on stocks and saying well the average rate is 8% gain per year, so stocks must return 8% every year! Clearly they do not.
Your link to the census bureau numbers are useless without further information. They are only tracking new home sales. (hint: You won’t be able to sell your investment property as a new home in 30 years). You also need to have details on how the size of houses sold have changed over the years, what newer materials/equipment is included in these homes. You cant just ignore these factors that increase sale prices and claim it is all appreciation.
I’ll ask you the same question that Ryan hasn’t/won’t answer: If you think your house will appreciate at a rate faster than workers wages rise, who is going to be able to buy all these houses in 30 years?
Even if real estate in the US over the last 50 years has only appreciated at the rate of inflation, that doesn’t mean that investing for appreciation is an invalid approach. The rate of appreciation varies widely over periods of time, geographic locations, property types, etc. Investors who understand economic cycles and the know their markets well can and do invest for appreciation all the time. It’s not my preferred approach, but it works.
At any rate, I really don’t see any reason to get into a pissing match with some anonymous internet troll who likely has never owned any investment real estate and probably never will. Armchair QBs are a dime-a-dozen, and their opinion usually isn’t even worth that much. Why waste time on it?
Ryan Waggoner,
I made a statement that you conveniently supported with your own link. You admit you believe my statement is true in the long term, yet insist that certain “investors” have mystical abilities to predict the next hot real estate markets in the short term. You give no examples of such “investors”, yet claim it is the path to riches that we should follow.
Of course I don’t own any investment real estate. Why would I own any when I’m here telling people the reasons I think its a bad idea? Notice how I’m being consistent?
On the other hand you are telling people how great investing in real estate for appreciation is and how they can become millionaires (or maybe even billionaires!) by investing in real estate and then come back saying “it’s not my preferred approach, but it works.” If it works why aren’t you doing it? Notice how you are being inconsistent?
If you didn’t want to debate and defend your opinions, why are you posting them? And I’m supposed to be the troll? Unbelievable.
My own real estate investment has worked out well for me. (I refer to a rental property; while my own residence has appreciated considerably, it is where I live, not an investment).
I purchased a duplex in my own, solid neighborhood in 2000 for $100,000. The property is now worth about $160,000.
My monthly cash flow is about a $350 after all expenses. Modest improvements in a year or two will increase my cash flow to about $1000 per month (and make my two college aged kids tuition payments).
THe current property value of $160,000 would appear to be about a 5% annual appreciation of my $100,000. Nothing to write home about.
But…
… in reality, my $100,000 was actually only a $10,000 down payment: my tenants have effectively made every mortgage payment for me, making my annual return somewhere around 50%.
I don’t know where else I could have turned $10,000 into $160,000 in nine years with relatively little risk and reasonably good certainty.
Is rental property for everyone? Absolutely not. It takes commitment and knowledge of buildings and the willingness to interact with tenants. While the property does sit quietly and appreciate, it is a part time job, sometimes requiring only one half hour per month, but sometimes requiring a full day.
Location, location, location.
I recommend the book “Building Wealth One House at a Time” by John Schaub. It’s no get rich quick scheme; just logical, steady wealth building. As with all books, not all applied to me, but there was much to learn.
If you consider investing in rental properties, think carefully: are you the right personality to handle the task?
On another note, I would be the perfect candidate for flipping houses (a 20+ year carpenter with nearly exclusive experience with old houses). Unfortunately, its becoming a fad has killed the profitability, in my book. Slow and steady is the way for me (if you call %0 annual appreciation slow).
M Rad
Good thoughtful post, but what I’m curious about is how much the total purchase price is after you add the interest on the purchase price of $100,000 after the full term of the loan. Have the tenants paid the interest as well?
Thanks for the question Yana.
Yes, the rent collected has paid for principal, interest, real estate taxes and property and liability insurance, all of which are included in my mortgage payment. When I average out misc maintenance and repairs, I arrive at the $350 monthly cash flow number.
M Rad
M Rad, that’s great. You must be doing it right
It helps a lot if you can do a good deal of maintenance yourself.
I think a house is a horrible investment, but property as an investment vehicle is not… big difference there of course.
If you’re simply referring to residential property (ie less than four units) you’re probably right. However, real estate offers things that the stock market can’t which are most appealing.
-sweat equity.
-your own business
-the ability to directly change ROE, profit margins, etc…
-the ability to gain significant tax benefits
-minimal transaction costs through 1031 exchanges.
-complete ownership
Having been exposed to real estate investors at many stages of their careers it seems to me that over a long period (20-30 years) these guys beat the stock market significantly. However they also tend to be guys that play the same strategy as Warren Buffet in that they buy undervalued and hold for long periods of time. If you’re not worth a million in 20 years investing in income producing real estate you’re doing something wrong.
Couple of points:
- haven’t seen any comments on the idea that living in a private (one family) home is a quality of life thing versus a investment thing. The idea as real estate as an investment (for the average middle class American) is a modern day invention. It’s true a home represents the largest investment for Joe Smith from middle America, but don’t discount property taxes, maintenance, agent fees, when Joe goes to sell in the 30 years.
- there’s a big difference between residential property as an investment and large unit properties (multi building / units), as Ryan states. (the latter presents a bit more ROI).
- being a landlord has challenges if you’re a DYI type of person (if you really want to make money you can’t outsource maintenance, rent collection, etc.). Moreover, at least in the large cities, renters are becoming more transient and only living in rental units for a short period of time before moving on (try renting a unit in this market, it’s not fun).
Good though provoking article.
Best,
Scordo.com
What about real estate as an investment if you have the cash to buy rental properties outright?
Obviously there’s still risk involved, but your return would be a quite a bit higher without losing money on the interest due on a mortgage.
Just a thought to trigger some discussion.
You are buying an income stream, not just the wood and dirt. Instead of buying 1 property with $100,000 of your own money, you could finance 5 $100,000 properties with $20,000 of your own money for each. So you get the income from $400,000 you didn’t even spend plus the $100,000 you put down. All finance charges are easily paid back many times over by rents.
Jake – you’ve inspired me to ask a question, since you brought up finance charges. Let’s say that I purchase a home for $300,000, put $30,000 down and finance it at 5%. This loan lasts for 30 years. What is the total amount I will pay for this home, including interest? I actually do not know how to figure it out.
With all due respect, I have lived in two major U.S. cities and have met many people. I have never met an average joe who made it big in the stock market. I have met stockbrokers who make a good living due to charging clients $200 a pop for a sit down and they put that money in the stock market- or better yet U.S. bonds, while they invest their client’s money in the market. On the otherhand, I know 5 regular people who invested in properties in their early twenties and do not have to work at all by the time they reached their early forties. I know someone who invested $8,000 on a property in the Northern Liberties section of Philly in 1990- and he just sold it for $365,000.
Adding to my last post-
None of the people spent a lot of money on the properties either. They bought in up and coming/ shady areas for $20,000 or less and put another $5,000-10,000 in renovations. To the person who claims real estate is a horrible investment- please travel to South Philly or Brooklyn and ask Lanlords how they feel.