Dear Ney Ney,
There are a number of reasons to invest in real estate, and also a number of reasons not to invest in it. Personally, I think real estate is the best investment you can make because it allows you to generate large amounts of wealth with less effort than starting a business and less luck than investing in stocks. What real estate requires of you is discipline and patience. If you can’t be disciplined and you want immediate results, real estate isn’t for you.
Real estate, like any investment, has some amount of risk, and strengths and weaknesses that need to be compared with other investments. Only when you compare the risks and the rewards and the strengths and weaknesses are you able to make a smart decision about if you should invest or not.
With real estate it can be hard to determine the risks and rewards because there are so many ways to invest in real estate. For example, many people who buy homes to repair them and resell them quickly, also known as flipping, say they are real estate investors. People who lend money to people who buy houses to renovate them also say they invest in real estate.
However, these activities usually have a much different level of risk than people who buy houses to own for a longer time and rent out. Of course, it is certainly possible to lose money with long term rentals, but for many reasons long term rentals are likely less risky than flipping.
Let’s talk a little more about the actual rewards, risks, advantages,
and disadvantages.
Rewards first. Real estate is potentially the most consistent way to build wealth and pass it from you to your family after you die. Over the long term real estate generally does not lose value. You can have a large amount of control over how your investments perform, if you want. Investing in real estate means that you are helping provide a home to other people, which can also give you a sense of well being. Real estate investing also gives people the opportunity to build lasting friendships through their investing. It is impossible to invest in real estate without the help of others.
Now that you understand the rewards, let’s talk about the risks. The biggest risk is that you lose the property and this impacts your personal finances. The amount of risk depends upon the type of property that you buy. When you buy a house to live in or any non-commercial property like a single house to rent or a small multi family apartment building with less than five units, you are responsible for the mortgage. This is called a recourse mortgage because the bank has a recourse, or way to be reimbursed for the full amount of debt personally by you.
If you are unable to pay the mortgage then the bank can take the house from you. This process is called foreclosure. During a foreclosure you lose any equity, such as your down payment, that you had in the house because this money goes towards paying back the bank. Even after a foreclosure you might still owe the bank money, and the only way to not pay the bank back east to declare bankruptcy. Bankruptcy means going to the government, telling them that you have no money, and asking them to release you from your responsibility to pay your debts. Foreclosure and bankruptcy have a very negative impact on your credit score. This makes it very difficult to buy, or even rent, a home for many years because banks and landlords won’t trust that you will pay them what you owe them.
When you buy commercial property, usually the loan that you use to buy a property is a non-recourse loan, which means that if you cannot pay the mortgage then you lose the property but it does not impact your credit score. You also cannot be personally held responsible for the debt, so you will not be forced to declare bankruptcy.
Many people who talk about the advantages of investing in real estate talk about four advantages: income, appreciation, tax benefits, and leverage.
If you are careful about which property you buy, rent from the property should be more than the expenses from the property each month, providing you with rental income. This rent is also called cashflow and properties that provide it are called cash flowing properties. Since rent usually rises overtime but your mortgage payment on a property stays the same, overtime your income from the property increases.
Appreciation is the increase in the value of the property overtime. Real estate usually increases in value over time, at least as much as inflation, but if you purchase property for a good price or in an growing area, it can rise faster than inflation.
The government usually allows people who own real estate to pay less in taxes. This is because the government wants people to provide houses for rent to people, so it uses lower taxes as a way to encourage people to invest in real estate and provide rental homes to people. Leverage is another way to say that you can get a loan, or a mortgage, to buy real estate. Banks will loan you money to buy real estate because they know that the real estate has value and if you don’t pay them they will be able to take the property back and sell it so that they won’t lose money. That means that you can buy a property for a small amount of the cost. A bank will typically not lend you money to buy stocks because stocks are normally a riskier investment than real estate. You can get a loan to start a business, but these loans are typically more expensive than a loan on a house because you have to pay a higher interest rate to the bank for the money.
These are all great advantages, and good reasons to buy real estate. However I think there are three other advantages to real estate that are even more valuable.
First, real estate is easy to understand. The basic concepts are simple and the math is not hard. You don’t need a college degree to invest in real estate.
Second, being a real estate investor is a great way to help people and the community in which you live. Providing nice housing to people at a fair price makes you feel good, and making old houses nice again is a great way to make your neighborhood a nice place to live.
Finally, if you invest correctly, real estate does not take very much of your time so you are free to pursue other activities that you enjoy.
There are of course, disadvantages with real estate, too.
I would say it is a slower way to build wealth. Papa did you buy they provide you some income but for several years you might want to see it in case something goes wrong with the property, and in most cases do you return on the investment is somewhat low.However, every month that you make a mortgage payment, the only more and more butter. This is called building equity, and I have a large amounts of equity in the property is a way to be wealthy. Having this equity means that you will have lower expenses so you earn more income from the property, and if you need additional money you can take a loan based on the equity without having to sell the property. Part of this equity comes from paying down the mortgage and part of it comes from the property appreciate the value, but those mortgage play down and appreciation take a long time.
A second disadvantage is that usually you need a very large amount of money to invest in real estate. It is very difficult to buy real estate without a down payment. On investment properties usually a bank wants you to provide 45% on the price of the house as a down payment. On a house that you are going to live in sometimes you only need to provide 5%, but even 5% on a $200,000 house is $10,000.
There are some people who try to tell you that you can buy houses with no money down, but many other people who will tell you guys are only trying to sell you very expensive courses on how to do it, and your money is probably a better spent buying an actual property. That’s one way to reduce or for the down payment is to partner with someone who has the money for a down payment. If you can find a good investment deal then the person might agree with you to partner with you since you found the deal they will give him the money for the down payment.
The third disadvantage is that real estate and be difficult to sell when you need the money from it. An asset that can be hard or slow to sell is called an illiquid asset. Sometimes you might find yourself in a scenario where you own several properties, but you need cash. Maybe there is a medical emergency. Maybe you need to buy a bigger house because you had another baby.
If the economy is not doing well it might be difficult to find someone to buy your house, or at least to find someone to buy the house at the price to sell it at to make the money that you need. Even if the economy is good and you can find a buyer at the price that you need, usually it takes one to three months to sell a house and get the money. It is important when you invest in real estate that you have enough cash or other liquid investments such as stock that you can sell in case you need cash quickly.
The last disadvantage is related to do you liquidity of real estate. Because real estate is a liquid it requires you to be disciplined and think ahead. When you decide to buy real estate you need to be patient to find the best deal that you can. Don’t let fear of missing out on buying a house cause you to make a bad long-term decision.
Real estate requires that you keep your personal finances in line. Sometimes with real estate there are unexpected expenses, such as repairs. You cannot always depend on the income from a property for your expenses. You need to stay disciplined to save money and keep the proper amount of money on hand for each property so that you can pay for repairs or cover the mortgage if you don’t have a tenant paying rent for a month or two.
Now that you better understand the advantages in disadvantages of investing in real estate you are better prepared to decide for yourself if you want to invest real estate. I think real estate is the best long-term investment and I hope that you will strongly consider it as an investment for yourself.
I love you.
Dad
