Editor’s Note: Yesterday Sarah gave us some ways to help you figure out if you’re ready to buy a home. But what if you’re pondering buying real estate not as a home, but an investment? Real estate investing involves more risk and legwork than investing in, say, a mutual fund, but successful real estate investors reap handsome rewards. Tempted? Here are some things to consider. Also: Tomorrow we have some advice on getting a mortgage to buy rental property. –David
You can invest in anything:
- Other people’s debt.
- Barrels of whiskey.
- Your cousin’s nightclub. (Warning: This is how many pro athletes go broke.)
Of course most of us hear “investing” and think 401(k)s and mutual funds. But maybe that doesn’t excite you. Maybe you want something more tangible than shares of stock. Maybe you want an investment that can provide cash flow now and a promising return over time. Maybe you’re thinking about investing in a rental property.
As a Realtor, I’ve chosen to investment mostly in real estate. But it’s not for everybody.
Why Invest in Real Estate?
Why do I feel real estate is the best investment? Because once I have a tenant, I like getting paid without work!
Each month my husband and I collect $600 cash flow on a rental property we own without having to do anything. (Cash flow is money in our pocket after we’ve paid the mortgage nad expenses on the property). We’re leverging the bank’s money to make money for ourselves.
Of course there are risks involved (like any investment) and from time to time we have to make a repair. But if I want $600 otherwise, I have to go work for it. This idea of creating passive income is what drives many investors toward real estate invest (including my husband and I).
There are also tax benefits to investing in real estate. When it comes tax time, IRS publication 527 states that you can deduct that interest from your taxes. You can also depreciate rental properties and, when you decide to sell, you can do a 1031 exchange to defer taxes even longer.
What’s The Risk?
In investing, risk and return are inversely related. The higher an investment’s risk, the greater potential for return. Safe investments yield paltry returns (think about that FDIC-insured savings account earning you mere pennies each month!)
Some people prefer to stick to investments with guaranteed, despite low, rates of return. Others are huge risk-takers. My personal opinion is that it’s good to take some risk as long as you know what you’re doing or have an expert to guide you.
In real estate, your risk can vary widely depending on how much due diligence you perform. Some investors buy properties site unseen at auction. They get a great deal, but don’t know what problems await them inside. Your risk is lower if you buy a property after getting a title report, home inspection, and an appraisal, but you’ll pay closer to market value with less chance of wild appreciation.
Is Real Estate Investing For You?
Now here’s the downside to owning rental properties: you either have to manage them yourself or pay a property management company (often around 10%) to do so for you. Managing your properties yourself takes time. You’ll have to advertise the property, screen prospective tenants, collect rent and fix common complaints like clogged toilets and appliance issues. If your tenant doesn’t pay rent, you’ll have to evict as well.
Also, real estate is not considered a liquid investment. You can’t quickly convert a house to cash when you need to sell, at least not as fast as you can with stocks or bonds. If you look at the Case-Shiller Index, you’ll see that house prices have dropped significantly in the past few years, which makes it difficult to sell a property quickly if you need to.
That said, rental properties could be a good investment if you:
- Are comfortable with the risks (including taking multiple mortgages).
- Can qualify for the loan and stomach the potential additional unexpected expenses.
- Are knowledgeable about real estate or have help.
- Want an investment that is more “hands on”.
- Don’t mind the work involved (renovations and repairs, screening tenants, collecting rent, etc.)
If You Want to Get Started
Before you dive into investing in a real estate property, it’s important to take time to learn. Here’s a post to get you started, about how one guy in his twenties got started buying income properties.
You may also want to check out some books like Rich Dad, Poor Dad by Robert Kiyosaki and Buy It, Rent It, Profit!: Make Money as a Landlord in ANY Real Estate Market by Brian Chavis. Some community colleges even offer basic courses in real estate investing.
Finally, if you like the idea of diversifying your investments with real estate but don’t want to manage rental properties hands on, there are other ways. Real Estate Investment Trusts (REITS) are one example. REITs are securities that trade just like stocks but invest in real estate instead of companies.
Do you own rental properties? Why did you get into real estate? Are you happy with your investments?