If there is one area of “wealth creation” that seems to stand the test of time, it is real estate investments.
You know what they are: rental properties you own, locate a tenant, become a landlord and hope for the incredible historical returns the investment can produce. Like any investment, there are pros and cons and more importantly, some myths around its success, how easy it is, and why the ads on TV aren’t always true.
If you own any real estate for investment purposes, it can help increase your overall net worth. The goal is to own real estate that produces a nice rate of return (Total rent collected – total expenses) AND watch the asset appreciate to a higher value. "Stocks have returned, on average, about 8% to 12% per year while real estate has generated returns of 2% to 4% per year," says Peter Earle, an economist at the American Institute for Economic Research. Although Peter Earle is using national averages and there are variations between residential and commercial real estate returns, you will find data that supports over the long term, real estate investing often has lower to equal returns of a stock portfolio. However, keep in mind real estate and the equity you build within it are less liquid than a stock portfolio. Having a diversified portfolio of investments (stocks, real estate, cash, bonds, etc.) is key to giving you cash flow flexibility and asset returns that don’t always correlate.
One of the most important factors when considering Real Estate investing is the total expense of the home, with most of that expense related to the mortgage. With the rise in mortgage rates over the past year, we have seen fewer buyers of Real Estate for investment purposes, mainly due to great risk of lower cash flow. Prior to rising rates, many real estate investors were able to generate strong net income from the rents collected vs the expenses. However, when mortgage rates rise, it becomes increasingly difficult to “cash flow” or profit from the property. Most new buyers today are unable to cash flow and ideally, will try to at least break even today in hopes of refinancing when rates drop and then creating positive cash flow. This is even more difficult in high-demand regions like many parts of sunny California where home prices are high and it is more difficult to be cash flow positive.
The other important factor is down payment. Many real estate investments require a minimum of 25%-30% down payment just to break even. The only way to generate immediate cash flow when purchasing an investment property in 2023 is to produce a much larger down payment, as much as 50%. The challenge is liquidating that much money to produce the down payment while pulling from another investment.
The last important factor is time and mental space. Unless you intend to hire a property management company (further cutting into your cash flow), be aware of the time it will take to address complaints, repairs, or possible evictions.
There can be great benefits to real estate investing and like any other investment, make sure you understand the risks associated with the investment, along with the opportunity for a great return.
President/Broker, True Point Lending