Should You Be Investing in Real Estate?

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Joshua Kennon co-authored “The Complete Idiot’s Guide to Investing, 3rd Edition” and runs his own asset management firm for the affluent.

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Joshua Kennon

Updated March 09, 2020

Simply stated, when investing in real estate, the goal is to put money to work today and allow it to increase so that you have more money in the future. The profit, or return, you make on your investments must be enough to cover the risk you take, taxes you pay, and the other costs of owning the real estate, such as utilities, regular maintenance, and insurance.

Real estate investing for the beginner can really be as conceptually simple as playing Monopoly once you understand the basic factors of the investment, economics, and risk. To win, you buy properties, avoid bankruptcy, and generate rent so that you can buy even more properties.

However, keep in mind that “simple” doesn’t mean “easy.” If you make a mistake, the consequences can range from minor inconveniences to major disasters.

The Balance

When you invest in real estate, there are several ways you can make money:

This occurs when a property increases in value due to a change in the real estate market. For example, the land around your property could become scarcer or busier, like when a major shopping center is built nearby. Or you could have made upgrades to the property that make it more attractive to potential buyers. Real estate appreciation is a tricky game because it is somewhat unpredictable, making it riskier than investing for cash flow income.

This type of real estate investment focuses on buying a real estate property, such as an apartment building, and operating it, so you collect a stream of cash from tenant rent. Cash flow income can be generated by other types of real estate besides apartment buildings, such as storage units, office buildings, retail establishments, and rental houses.

This income is generated by specialists in the real estate industry, such as real estate brokers, who make money from commissions on properties they have helped a client buy or sell, or real estate management companies, which get to keep a percentage of rents in exchange for running the day-to-day operations of a property.

A hotel management company might keep 15% of a hotel’s sales for taking care of the day-to-day operations, such as hiring maids, running the front desk, mowing the lawn, and washing the towels.

For some real estate investments, this can be a huge source of profit. Ancillary real estate investment income includes things such as vending machines in office buildings or laundry facilities in rental apartment complexes. In effect, they serve as mini businesses within a bigger real estate investment, letting you make money from a semi-captive collection of customers.

There are several ways to buy your first real estate investment. If you are purchasing a property, you can use debt by taking a mortgage out against a property. The use of leverage is what attracts many real estate investors because it lets them acquire properties they otherwise could not afford.

Using leverage to purchase real estate can be dangerous because, in a falling market, the interest expense and regular mortgage payments could drive you into bankruptcy if you aren’t careful.

To manage risk and protect yourself, consider holding real estate investments through special types of legal entities such as limited liability companies or limited partnerships, rather than in your own name. You should consult with a qualified attorney for their opinion as to which ownership method is best for you and your circumstances.

If the investment goes bust or someone slips and falls, resulting in a lawsuit, these legal entities can protect your personal assets, meaning the worst that could happen is you would lose the money you’ve invested. You will have peace of mind knowing that your retirement accounts and other assets should be out of reach.

Pros

• Less risk and volatility than the stock market
• Can be a good source of cash flow
• Los of tax deductions
• Properties deliver good long-term return

Cons

• Not as much potential for aggressive return
• Can require a lot of cash
• Poor liquidity
• Dealing with tenants and building issues can be difficult

• Lower risk than the stock market: The housing market isn’t subject to as much of the same volatility as the stock market. You don’t have the same earning potential, but you can count on a steady incline most of the time.
• Steady cash flow: When you have enough rental properties going, you can generate a reliable revenue stream for your business.
• Good tax breaks: Real estate investors can deduct all sorts of expenses from their taxes, including mortgage interest, depreciation, property tax, and more.
• Long-term returns will usually be positive: Over time, most properties will appreciate in value.

• Potential returns aren’t as high as the stock market: From 1991 to 2019, the S&P 500 gained over 600% while housing prices increased only about 160%.
• Real estate investment can be cash heavy: If you really want to get a steady income stream going, then you need enough cash on hand (whether your own or loaned) to pay for building improvements, maintenance, possibly a management company, and more.
• Properties are not liquid investments: You can’t turn a property into cash quickly like you can when you sell a stock.
• Managing tenants and building maintenance is a challenge: Whether you hire a property manager or manage it yourself, running a property is full of unexpected problems with overdue rent, roof leaks, power outages, and more.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.

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