Why Not Real Estate?
Why Not real Estate?
In yesterday’s post I asked why real estate?. The answer seems like a no brainer. There are several benefits including diversification, market inefficiency, and tax efficiency. So far sounds good. But like every asset class, there are also a number of down sides. There is no easy way to make sure money. You are always going to have to work a little and take some risks. Why not real estate?
It’s a little more complicated than the novice thinks. There are several risks and pain points associated with this fickle asset class. Many fortunes have been made and lost bowing to this slippery deity.
Leverage
But isn’t leverage one of the good things about real estate?
Well, yes, it does have its benefits. Starting with small sums of money, one can leverage their way up to owning large numbers of properties. Then with a little time and appreciation, returns sky-rocket. If I put $5K down on a $300K house and sell it later for $310K then I have tripled my money. On the other hand, If I put $10K down on a $300K house and sell it later for $310K than I have only doubled my money.
Although I prefer tripling to doubling, the down side of leveraging is risk. If the market drops drastically and I am unable to rent the property, I may be forced to sell at a loss or declare bankruptcy. The less ownership I have, the less I will be able to withstand the downturns and rebound again.
Why not real estate? Because leverage can kill a financial plan as well as it can support one.
Property Pain Points
Paper assets don’t break down in the middle of the night. VTSAX doesn’t need to be rented every year to make a profit. Taking on physical property involves a number of different types of risk. There is not only the risk that the property will not generate the appropriate returns or appreciation, but also that unexpected mechanical defects will cost both emotionally and fiscally.
If you are a landlord for long enough, some major catastrophe will happen in one of your units. The heater will break. Or a pipe will burst. Or a tree will fall into your roof. The possibilities are endless.
And it is not only acts of nature, but the human foibles you will struggle with. Potential tenants will back out at the last-minute. They will move out early and refuse to pay. Anyone who has gone through the eviction process will tell you how much of a pain it is.
Why not real estate? Because owning property takes a lot of work and sometimes generates more stress than returns.
Liquidity
How do you make money on real estate. You buy, hold, and rent. This is the formula that many of us adhere to. Not only will you cash flow monthly from rental income, but also will likely enjoy a few percentage points of appreciation over the long run.
In order for the investment to go as planned, you have to be ready to park your down payment for a number of years and accept that your money is illiquid. Selling a property takes time and should only be done during a favorable market.
If you find yourself in need of fast cash, you may be forced to sell at a loss.
Why not real estate? because you have to plan on kissing that money goodbye for years, maybe decades.
Final Thoughts
Why real estate? Why not real estate? It all depends on your perspective and risk tolerance. Certainly there is risk involved by over leveraging yourself in this rather illiquid asset. Furthermore, even if not financial stress, there are a number of pain points that come with being a landlord.
Many of these risks can be mitigated by avoiding the four wrongs of real estate, but not all.
if you are going to jump into this asset class, best to do your due diligence and invest wisely.