Why you should not invest in real estate
Photo by Issy Bailey
Beginning in 2016, I have been investing in real estate. Here is a list of the negative aspects of real estate investing. Pairs well with: Why you should invest in real estate
As always check out the obligatory disclaimer.
It's no secret that most real estate purchases require a large upfront cash outlay. This requirement makes real estate investing infeasible for most people.
I believe that income inequality stratifies further when real estate investing is out of reach for most people. The age old truism, “It takes money to make money” most accurately describes real estate investing.
I have some ideas about solving this problem....more to come.
Real estate can be a risky affair if you don’t know what you’re doing. I always recommend people invest locally first. In your hometown, you know where the good and bad areas are.
There is a huge amount of information for those looking to learn more about real estate investing. I listened to most of the first 100 or so of the Bigger Pockets podcast prior to closing my first deal. I highly recommend the podcast.
One very practical way to limit risk is to have strict investment criteria. In our case, each investment had to be cash flow positive - it had to make more money than it cost in expenses + mortgage. And not just by a little bit. We require at least a 10% cash-on-cash return for us to invest. Here's an example:
If we have an out of pocket cost of $100,000 to purchase a building, we require that building to make at least $10k per year after expenses and mortgage are paid. I realize that this is hard in many US metro areas. My recommendation in this case is to look outside the immediate metro area to the suburbs to find deals.
If you take this strategy for all your investments you’ll be able to cover your expenses and limit risk of bankruptcy in a down market.
It can take a lot of work to find a good deal. And then, when you find one and close on the deal, the real work begins. If you invest in apartment rentals and are self managing it can take a significant portion of your time. For example, I self managed our (then) 18 units for about a year. The work varied considerably per week but my time managing the properties averaged about 10 hours a week. You’ll spend more time the first week of the month tracking down rent and lots of time showing vacant units. Surprising - work order request was not a big deal (at least with only a small number of units).
As we grew we hired a property manager. This is essential if you want to grow your portfolio. It can cost 4-8% of gross rent to hire a property manager. But it is well worth the expense to not have to deal with a growing portfolio. However, the real trick is to find a good property manager. This was hard for us initially. Finding a good manager makes all the difference.
Real estate investing is flexible as your level of involvement can vary over time. When you are young and just starting out you can maximize your income by doing everything yourself. As you grow and want to take things off your plate you can delegate the management to a property manager.
There is some stigma associated with being a landlord. You hear stories about “slumlords” in the news. My experience is that most real estate investors are good people who are investing in their communities and want to do right by their tenants. On the other hand, I do know some true slumlords.
If you are a local professional, you may want to hire a property manager earlier in your investment timeline. It may be favorable to distance yourself from hard management decisions (think evictions, dealing with difficult tenants). This can help mitigate any stigma associated with you personally. Although, even then you may find some negative press if you don’t do the right thing.
Once you buy a building it is hard to get your money out if you need it. You can sell of course but that is complicated. You can also refinance a mortgage to pull out money - but again this is a process.
Lack of liquidity may be a good thing however if you are prone to spending.
Real estate can be out of reach for people who don’t have a lot of cash on hand. And there can be risks if you don't know what you're doing - so do your homework. Real estate investing does take extra work (compared to stock market investing) but you can use a property manager to offload most of the work. And do the right thing. Don’t be a slumlord