If you’re reading this post, you might have considered investing in real estate at one point but couldn’t quite make the leap. Whether you’re a savvy investor with knowledge of different investment vehicles or a newbie looking to grow that nest egg, real estate should be an important factor in your investment portfolio. So let’s take a look at some reasons why people get in or out of real estate:
“If you want to earn higher returns, you have to take more risk”
Really? Major investors like Warren Buffett have made a living investing in boring, safe assets and industries and generated relatively high yields. Real estate isn’t any different as a dependable strategy for growing your wealth. Depending on the investment strategy and by being conservative, real estate can still provide significant returns of over 16% annualized as you’ll see in Sucasa’s investor opportunities section.
“Real estate cannot be lost or stolen, nor can it be carried away. Purchased with common sense, paid for in full, and managed with reasonable care, it is about the safest investment in the world.” – Franklin D. Roosevelt
Unlike stocks and most bonds, investment in real estate is secured by the underlying property. Unless the property is located in a disaster zone, bricks and mortar don’t disappear overnight. Even then, properties can be insured against vandalism, fire, flood, earthquakes and the like. Against thieves, you can employ security systems, house-sitters, or sic your rottweiler on them (no please don’t, it could become a legal issue). Those same measures would be a little harder to apply to the Enrons and Bernie Madoffs of the financial world.
Stable Income Return
“Landlords grow rich in their sleep” – John Stuart Mill
Owning rental properties is a popular way to generate passive income with little effort to maintain it. Rental income that covers all expenses with surplus puts you in a position of positive cash-flow. People often think that the rate of return in rentals is low but that couldn’t be further from the truth. In the current world economy, central banks are flooding the markets with cheap money, property values are relatively low and rents are on the rise. It’s much easier to find Class A and Class B properties with >10% net ROI per annum these days. You might have started seeing a building spree of apartment buildings in your area already. That’s a sure sign that bigger institutional investors are committed to rental growth.
“Stocks outperform over the long term!”
Statistics of total annual returns between 1978 and 2008 have described residential real estate as 5.68%, commercial real estate at 9.99%, while similar investments made into the S&P500 returned 10.84%. Bonds came in at 6.72%. But how do you define the long term? 10 years? As John Maynard Keynes, the economist, once said, “In the long run we are all dead”.
I’m not out to pooh-pooh other investment vehicles like stocks and options. These are certainly viable and offer solid returns if you choose wisely, but that’s a big IF. Putting all your eggs in one basket is a big and unnecessary risk. It’s important to diversify your entire investment portfolio and not just your stock portfolio.
Because real estate is backed up by… well, real estate, there’s implicit collateral behind every investment. That’s why there’s lower volatility while providing a higher rate of return per unit of risk.
“I’m proud to be paying taxes in the United States. The only thing is — I could be just as proud for half the money.” – Arthur Godfrey
Real estate investments can provide valuable deductions for depreciation and business expenses. Think about the new fruit trees you could have planted and harvested last year in your rental property. Or that boating trip you just happened to take to check out those wonderful waterfront properties.
Another popular real estate tax benefit specific to the US are 1031 exchanges. These allow for the sale of your property and reinvesting the proceeds into more expensive properties while deferring taxes on any gains.
“You can’t time the market”
This old adage keeps most people either fully invested or completely divested. While it’s a bad idea to catch the market’s twist and turns, real estate is a very local enterprise and geographically constrained. Timing is a matter of perspective and depends on the real estate strategy being employed. Today’s market with overwhelming foreclosures and limited affordability among the younger generation gives us an opportunity to invest in good value residential flips and rental properties. There’s always an appropriate real estate strategy for every situation.
A Problem: Liquidity
“Define the financial term ‘liquidity’: When you look at your pension plans performance in 2008, and wet your pants” – Stan Kegel
The main difficulty of real estate investing is liquidity, specifically the lack thereof. Unlike stock transactions which take just seconds, a real estate project can take several months to close and convert into cash.
REITS (real estate investment trusts) and other listed real estate companies are an alternative solution to the liquidity problem since they provide indirect ownership of real estate assets. However since they are publicly listed, their values are subject to the vagaries of real time market movements.
The Bottom Line
Like all other investments, real estate isn’t an easy business. It’s a serious endeavor that requires energy, patience, expertise and a bit of luck. Thankfully it’s simpler to understand and liquidity concerns can be mitigated if the investment is done right. I’ll talk about that in another post since I cover that extensively with my own investors.
Now before I end, I realize that there is an underlying belief that real estate investing can only be done with older folk. But investing at an early age is not only possible but beneficial. Start young and explore your options.
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