Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a new or experienced investor, these weekly updates are designed to give you advice on picking stocks and other investment topics that will help you develop a successful approach to investing. Each Investor Toolkit update gives you a fundamental tip and shows you how you can put it into practice right away.
Today’s tip: “What makes investing in real estate different from your other investments is not just the nature of the risks you run, but the extra work you will have to do.”
Before you decide whether investing in real estate should play a significant role in your finances, it pays to compare it to other forms of investing.
Many individuals have grown rich through part-time involvement in real estate—probably more than have done so through the stock market. However, that’s mainly because of three key factors that are easy to overlook: leverage, sweat equity and higher risk.
It’s easier to get financing for real estate than for stocks because real estate tends to be less volatile and easier to appraise, and it generally produces more current income. It also rarely drops drastically overnight, as some stocks do from time to time.
Real estate investing enthusiasts say that if you buy a property with a 10% down payment, then a 10% rise in its value means you have doubled your money. However, that claim neglects the costs of selling (up to 5% or 6% for real estate commissions, plus lawyer’s fees and related expenses). It also overlooks any negative cash flow you may have experienced when you owned the property, because rents failed to cover expenses.
Eventually, rents can rise to a point where they cover the mortgage, taxes, maintenance and other expenses. By then, you may have a big capital gain. But that can take many years. Meanwhile, you have to “feed” your property, as real estate investors say – that is, invest additional funds to cover the shortfall between rents and expenses.
“Sweat equity” refers to the time you have to spend dealing with tenants, arranging for maintenance, doing the accounting and so on. You can hire others to do these tasks for you, but that can get very expensive. You might say that owning real estate is something of a cross between an investment and a part-time job.
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Traffic patterns, backed-up sewers and zoning changes
Higher risk comes into it because real estate is illiquid, expensive to manage and to buy or sell, and highly concentrated geographically. Rising crime, unpleasant neighbors and other changes on the street or in the neighborhood of your property can make it hard to find tenants or buyers for your property. So can physical problems like nearby sinkholes, adverse traffic patterns, backed-up sewers, and zoning changes that allow undesirable development, or that limit what you hoped to do with your property.
Many people start out investing in real estate with high hopes, and wind up selling a few years later, with little profit if not losses. They have turned into what the industry refers to as “don’t wanters”—investors who have become discouraged by risk and management problems, and who simply want to get out of their real estate investments as soon as possible.
Many real estate fortunes have been founded on buying so-called “distressed properties” from don’t wanters. Doing that takes a lot of patience, shopping and haggling, on top of the usual demands of the business.
Most real-estate millionaires earned their profits by taking on a lot of risk, worry and work. They also went into the field with realistic expectations and the intention of sticking with it for many years.
Many also owe at least part of their success to timing: they bought when real estate had been in the doldrums for years. If you buy near the end of a boom in prices—a good way to describe today’s real estate market—you may need to wait for a subsequent boom before you can sell at much of a profit.
COMMENTS PLEASE—Share your investment experience and opinions with fellow TSINetwork.ca members
If you have bought real estate as an investment, how would you assess the results? If the investment has worked, what do you think are the main reasons for its success? If it hasn’t payed off yet, what do you think has caused it to fall short of your expectations?
Article originally published November 15, 2012 – Updated April 9, 2014.
Comments
W
Real estate investment is for the long term and is one way of enforcing a saving plan. The key as always is know what you are buying – location, location, location. Stay away from remote areas, stay within growing cities, preferably with view properties. I and our children, now three adults, have all benefited from a forced saving plan that slowly paid off the mortgages, generated a positive cash flow and provided long term capital gains. WT.
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Real estate investment is for the long term and is one way of enforcing a saving plan. The key as always is know what you are buying – location, location, location. Stay away from remote areas, stay within growing cities, preferably with view properties. I and our children, now three adults, have all benefited from a forced saving plan that slowly paid off the mortgages, generated a positive cash flow and provided long term capital gains. WT.