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Should You Invest In Real Estate?

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

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You can invest in anything:

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?

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About Sarah Davis

Sarah Davis is a real estate broker in San Diego, Calif. She enjoys helping both buyers and sellers and was voted one of the top 10 best real estate agents in San Diego in 2013 by Union Tribune readers. In her spare time she talks about real estate on a local radio show and manages her website RealtorSD.com.

Comments

  1. Real estate investing is awesome! We have a rental property that we rent to a family. We also have a basement apartment in our house that we rent to 2 university students. The most important thing is proper screening and tenant selection… after that it’s easy as pie. Our tenants have been renting for 3 years and 2 years… and our time commitment has probably been about 10hrs per year worth of property maintenance, repairs, lease renewals etc. It’s such a profitable and easy investment… but it does come with big risks.

    • Congrats Julie!!

      It sounds like the investment is working out well. One huge key to keeping things “easy as pie” is to buy in the right location. Numbers aren’t everything and I’m even willing to take on a lower return to have piece of mind.

  2. I have had some family members start looking for properties down in areas where the “snowbirds” are starting to move to. Kind of a good idea….as long as the “snowbirds” don’t move back and forth – leaving the apartment empty for some months.

    • Jeff,

      My two cents – stay away from vacation rentals. Look for more solid “bread and butter” deals, ones where you’ll have a tenant occupying the property on a more permanent basis. The asset will be more stable and will substantially out preform the vacation rental (pending your purchase correctly).

      AG

  3. I see you’ve found the power of passive income! That’s great!

    People need to keep in mind that passive income typically requires a lot of upfront work with no pay . . . but when the money starts rolling in, you’ll be glad you invested your time into the endeavor!

    Real estate is a great way to achieve some passive income in your life. Thanks for a great article!

    • Passive income is great! You are right that it first takes a while to set it all up. But if you have proper execution and work ethic, then it usually will pay off in the end!

      As Derek Sivers says, “Execution is worth millions:

      * Awful idea = -1
      * Weak idea = 1
      * So-so idea = 5
      * Good idea = 10
      * Great idea = 15
      * Brilliant idea = 20

      * No execution = $1
      * Weak execution = $1000
      * So-so execution = $10,000
      * Good execution = $100,000
      * Great execution = $1,000,000
      * Brilliant execution = $10,000,000

      To make a business, you need to multiply the two.

      The most brilliant idea, with no execution, is worth $20. The most brilliant idea takes great execution to be worth $20,000,000.

      That’s why I don’t want to hear people’s ideas. I’m not interested until I see their execution.” —Derek Sivers”

  4. Good motivational post (much like Kiyosaki’s books) but the devil with real estate is in numbers and those are lacking. PITI payments are very predictable. HOA expenses are fairly predictable. Maintenance expenses are predictable only over the long run — you spend 10-20 years between roof replacements but they hurt when they happen. Count on maintenance costs of 1.5% of home’s value annually if you want to stay conservative. Vacancy rates and tenant problems (damage, non-payments, eviction costs, lawsuits) are very unpredictable. Appreciation, if any, is unpredictable as well and should not be counted on to exceed inflation. Bottom line your rents better be bringing in 150% of PITI or more (I prefer 200%) if you want a truly solid investment. Counting on short-term appreciation or ignoring details altogether in favor of motivational speeches is not a good idea.

  5. Long-Term Returns is right. You have to hedge against the reality of property ownership. It’s nice when you have good tenants, it’s awful when you don’t. It’s great when you have little maintenance, it’s terrible when there’s damage. You have to count the real cost of each property and consider it’s rent-ability and the local market.

  6. I’m 24 years old and have started investing in real estate and am currently in the process of closing on 2 homes. I would like to eventually one day retire and live off of the residual income these properties will generate. Naturally, in order to survive, both my wife and I would require more than just two properties :-)

    When I first started into this back in January, I spoke with my loan officer and he said that Fannie Mae and Freddie Mac would allow someone no more than 4 loans, including their primary residence. In your blog it states that someone could have up to 10. If this is true that is great news, but how or where would I go to see if this is still the case? I saw the hyperlink that that supported your statement was from February of 2009, would there be something more current?

    Please give me your thoughts.

  7. You’ve shared a lot of good points on this post. The real estate industry is really not something one should get into without some knowledge about it, and this kind of post would surely help real estate investors make the right decisions.

    You mentioned that house prices have dropped in the last few years, and although that is true, it actually is an indication that this is the best time to invest in real estate. In fact, that’s what many real estate moguls are doing right now, investing.