Pros and Cons of Real Estate Investing

(a primer for first-time investors)

There’s a lot of chatter about the ups and downs of investing in rental real estate.  Some of the concerns are valid.  Others are fear hypes or clickbait.  In this document, we will dispel the myths and get down to the real truths.

This information is based on my 45+ years of experience with investment real estate.  It is certainly not the final word.  Consult an attorney before doing something you’ll regret!

I should also forewarn you that I am bullish on rental real estate.  I got into it in the mid-1980s, and by the late 1980s, I had figured out what it could do for me financially and moved “all in”.  I can’t say it has always been a cakewalk, but if you persevere, it will pay out big!  I’ve never looked back!!

Pros

1.      Incredible ROIs

The big attraction to rental real estate is not in the income it produces. It usually doesn’t produce much if any income, and sometimes you have to ‘feed’ it.  The big attraction to real estate is the wealth it creates.  The Returns on Investment (ROIs) are like nothing else!

I have always used (and heard) that 8% is a good ROI for stocks and mutual funds – the investment option most commonly used to compare against real estate.  Over my 45+ years, I have consistently seen with my own portfolio and that of others, ROIs in the range of 30-150%!!  Yep, you read that right.

Check out video #8 in our Video Center for a fuller explanation.  Then go to our Real Estate ROI page for an in-depth discussion of real estate ROIs.

2.     Passive Wealth Building

Real estate appreciates passively.  Sure, there are some decisions you have to make from time to time, but it does not require constant attention.  If you hire a good property manager, then the investment becomes even more passive.

3.     No investment management fees

Your real estate is not included as a managed asset with your financial planner.  That means no financial management fees.  Yes, there are property management fees.

We only bring this up because some financial planners are quick to give advice to clients to sell their real estate.  They are unfamiliar with the incredible ROIs real estate generates, and they also want to include that equity in their management fees.

4.     Diversification / Inflation Hedge

Real estate is known to be a great hedge against inflation, adding further protection to your overall portfolio.  You’ve got the IRAs, Roth IRAs, 401(k)s, and all of the other instruments invested in the market.  Real estate is a complementary diversification asset to market investments and gives you that inflation hedge.  In addition, real estate is a long-term investment that can lie over shorter-term investments.

5.     Wealth Transfer Tool

Under current tax law (subject to change without notice!), real estate gets a ‘stepped up’ basis tax-free when transferred to an heir.  For example, say you buy a rental for $200,000.  You own it for 20-30 years, and when you die, it is worth $600,000.  The property will get re-appraised at $600K and be included in the estate (subject to estate taxes).  If your estate is under the tax-free threshold, then all of that passes into your heir’s possession tax-free!

There are two caveats to that.  One, in order for that to happen, you have to die!  None of us is getting out of this thing alive, but it means you do not get to enjoy the capital gains – your heirs do.  (BUT, you do leave a legacy!)  Second, if you are over the estate threshold, then your heirs will be paying taxes on that stepped-up valuation.  Most people are below the threshold.  If you think you might be above it then consult with an attorney or financial planner on trusts and other vehicles to legally circumvent the taxes.

See video #41 in our Video Center for further discussion on this.

6.     Low risk to return ratio

All investments carry risk.  Owning real estate is no different.  But relative to the returns it generates, real estate has a low risk.  To earn returns like real estate continually delivers, an individual would have to invest in instruments far, far riskier than real estate.

7.     Don’t need a PhD

Owning rental real estate does not require a lot of real estate knowledge or training…particularly if you have a good property manager in your corner.  We all grow up in homes and are familiar with the nuances that arise.

 

Cons

There is no perfect investment, so stop looking!  Go in with your eyes wide open.

1.  Tenants from hell

Everyone has heard the stories – squatters who won’t pay the rent and trash the house.  While those stories are mostly true, they are extremely rare!

2. Liquidity

While the ‘tenants from hell’ is a perceived fear, liquidity is real estate’s biggest hurdle.  If you need money, it’s not like you can throw up a ‘for sale’ sign and close next week, like you might be able to do with stocks and mutual funds.  For this reason, real estate investing requires three things: 1) long-term thinking; 2) cash, and; 3) patience.

For further information on this topic, refer to video #27 in our Video Center – Cash is king!

3. Patience

Partly because of the liquidity issue, a real estate investor needs patience.  It is pretty hard to switch horses midstream.  Patience to weather the storm, whatever it may be, is a character quality of high value in real estate investing.

4. Paradigm shift

This is a big one for a lot of new landlords.  Most of us are told, “Get a good education and find yourself a good job.  Stick with it, and when you are old, you can retire.”  Sounds simple enough, so we go off and do it.  No one tells us that being able to retire comfortably is a ‘maybe’.

Plus, we are oriented towards that paycheck – a short-term goal.  Real estate is long-term, and that changes the thinking around to what we are used to.  Instead of income, we look at net worth and rate of return on investment.  We use terms like ‘wealth’ that are uncommon in many circles.  Instead of a 1-to-3-year planning horizon, we are looking 5-10 years down the road.

5. Capital improvements

Buildings deteriorate and need constant repair and improvement.  The small stuff is no problem.  Bigger issues like a new roof, a side sewer, or kitchen remodel require advance planning to avoid a cash squeeze.  Creation and development of a capital reserve over time eases the anxiety of writing a big check, or worse yet, losing the property to the bank.  Have cash available when investing in real estate.

Video #13 in our Video Center emphasizes the need for a capital reserve account.

6. Cost of entry

Not everyone is walking around with tens of thousands of dollars to put down on a rental property.  Getting into real estate as an investment has a high cost of entry.  Fortunately, the first one is the hardest.  After acquiring the first rental, equity builds, and so do the options.

 

Conclusion

Real estate investing is not for everyone.  Neither is wealth!  To have what others don’t, you need to do what others won’t!  Simple as that.