Many people often wonder why people invest in real estate instead of another type of investment, such as stocks or gold. Although learning how to invest in real estate is complicated, there are a few advantages of investing in real estate over traditional mediums. There are also a few disadvantages as well; both will be covered below!
Why Invest in Real Estate – Advantages of Real Estate
Investing in real estate may generate more profits for the average investor than investing in the stock market. Unless you have an above-average knack for picking the best stocks, investing in real estate tends to be a more straight-forward and profitable proposition, even though learning how to invest in real estate involves a lot of steps.
In fact, real estate can generate huge returns if you find the right house. If you can buy the right house at the right price, you can fix it up and rent it out often for at least the same amount as the mortgage on the house is worth, or sometimes even more. So while you may not make much money initially, once the mortgage is paid off you can then sell the house for profit, or continue to collect rent for profit.
The idea here is that unlike a stock, you not only get big returns (rent) but the property also appreciates (if conditions are good) like a stock.
The idea of leverage is really appealing to those looking to buy into real estate. Since most people invest in real estate through a loan or a mortgage, it is possible for a person to use their equity to purchase multiple rental properties, and then use the rent to pay the mortgage. This will ultimately lead to (in theory) multiple paid-off properties which can be sold for a large profit or used as an income stream.
Let’s look at an example:
- You get a loan for your first investment property, and after putting $30k down and $10k in renovations, you are able to generate a few hundred dollars per month in profits and pay the mortgage, taxes, and fees associated with the property.
- That 300$ now is adding to your income stream, so not only are you paying off the loan but you are generating more money as well. Furthermore, you are able to generate more equity, since the equity you put into your home increases your net worth.
- A few years later, you are ready for your next property. Now, you only have to spend $20k down on your property because you have more equity. You are also able to generate $300 a month on this house.
- Just a year later, you are ready for your next property. You only have to spend $15k this time becuase you have more equity, and are able to generate another $300 a month.
- Now you are pulling in almost $1,000 a month in profit and gaining a few thousand dollars a month in equity (which you can realize whenever you sell your properties).
With these new income streams and equity, you can keep buying more and more homes to rent out, at a faster rate. A successful rental property landlord is essentially running a business with enough income to support the landlord and enough equity to retire on eventually.
At least that is the way it looks on paper, but not everything goes as planned, as evidenced by the mortgage meltdown of 2008. Investment properties were thought to be a big cause of that as banks were issuing loans to those without the means to pay the mortgage.
However, many of these investors were speculators, hoping they could turn around and sell (flip) a house a few months later for a big profit. They were not hoping to start a rental property business.
Regardless, the lax requirements for investment-property mortgages and allowing people to get too much leverage off their equity (and in some cases, lack thereof) lead to the mortage crisis of 2008. As a result, it is now harder to get loans for investment properties to generate this large amount of leverage. You now have to put a lot more down on a home and often pay higher interest rates as an investor, making it harder to rapidly increase your wealth and equity.
On the other hand though, investment properties are much cheaper now and the amount of rent you can charge compared to the property’s total value has improved, making rentals potentially more profitable than pre-market meltdown, if you can manage to get a loan.
Why Invest in Real Estate – Disadvantages
The upside to investing in real estate is pretty obvious: you can rapidly generate equity and income streams through your properties. However, there are a lot of downsides to owning real estate as well.
The biggest downside to owning real estate as an investment is that it is not passive. There is nothing passive about owning a rental property or even just a piece of land. Here are just some of the things you have to consider:
- If you are not purchasing new homes, you may have to spend money to fix up the house;
- You have to perform repairs for your tenants;
- You may have to pay property tax on your property;
- You have to find tenants;
- Tenants may cause damage to your house
Many people think they can get around this by hiring a managing company. However, managing companies often charge up to 10% of the monthly rent. You are going to be hard pressed to pay the mortgage, taxes, and rental company and generate a profit. You may even be at a slight loss in money (but still be generating equity) if you hire a managing company.
I think in general, owning a rental property is perfect for an investor that both lives near the property and also has some skills. It can be very expensive to call up a contractor to fix something wrong with the house, so if you do not mind doing some of the work yourself, you can really save some money.
Real Estate and Liquidity
Another major downside that is rarely discussed is its lack of liquidity. When you buy a property, it is not something you can easily get out of. If you need money due to a crisis (loss of work, disability, disease, trouble with the law, etc), it can be hard to get it out of your investments.
Selling a house and actually getting paid for that house is not something that happens over night. Conversely, you can easily put in an order to sell some of your stock, sell it that day, then transfer the money back into your bank account and have it available for use within a few days.
As a result, while you may have success with investing in real estate, you never want to make real estate your whole portfolio. Learning how to invest in the stock market and how to invest in gold is recommended to compliment your portfolio. Stocks offer liquidity whereas a bit of gold (~10% of your portfolio) offers protection against currency devaluation and economic crisis. You never want to put all of your investing eggs in the same basket.
Why Invest in Real Estate Conclusion
At the end of the day, rental properties and real estate investing in general are more suited to those that want to play an active role in their investments. No one is going to spray graffiti or bust out the windows on your stock portfolio, but that is something that might happen with real estate.