Investing in Real Estate: Pros and Cons
Investing in real estate can certainly be an excellent strategy for building wealth. However, as with every type of investment, it presents varying degrees of risk. In this article, we'll discuss the pros of cons for real estate investing in general, without focusing too much on any specific niche. Spoiler alert: we think there are way more pros than cons.
Options. There are many different ways to invest in real estate. You can invest on your own, with a partner, in a syndication, or even a large fund. You can purchase single family homes, small multifamily properties (2-4 units), large apartment complexes, commercial buildings, self-storage facilities, mobile home parks, and much more. You can buy distressed properties and add value, or you can buy "turn-key" properties that cash flow from day one. You can buy for the long-term or fix and flip. You can rent out to long-term (12 months +) tenants or you can offer short-term usage. You can even focus on development and turn a plot of land into a usable, rentable property.
Involvement. Offers the ability for active or passive involvement. Some investors, especially those just starting on the path to wealth generation, prefer to take a hands-on, active approach to investing. This is most common in the single family and small multifamily space. For those seeking to be less involved by letting their money work for them, and wanting to be involved in much larger projects, this can most commonly be done by joining a syndication, most often in the commercial real estate space (large multifamily, self-storage, mobile home parks, etc.).
Tax advantages. Real estate ownership can offer tremendous tax advantages. This can become very complex depending on each individual's situation, so we will cover this topic in much more detail in a separate article. However, in general the most common tax advantages are various deductions (qualified expenses), depreciation (helps offset yearly costs therefore reducing taxable income), and tax deferment (re-investing proceeds from a sale into the purchase of another property using a 1031 exchange).
Easy to Understand. While real estate can certainly get quite complex, especially when dealing with legal and tax details, in general the basics are easy for the typical investor to understand. You buy a property, maintain it over time, and the individual or entity that uses your property pays you to do so.
Leverage Debt. The real estate industry is filled with loan products that vary in length, rate, and terms. Owners of real estate can leverage this debt, often at considerably low interest rates and for a long period of time, to scale much larger and faster than would have otherwise been possible. Most commonly, the rental income from the property can be used to pay off this debt each month, therefore increasing your equity over time using other people's money. There are also many short-term loan options, both private and institutional, that can be utilized for various purposes, but at a much higher interest rate.
Control. Much more control of the investment vs. alternative options. The active ownership of an asset, from single family homes to large apartment communities and everything in between, has tremendous control over the return on investment. They have direct control over the management, maintenance, marketing, vacancy, and more - all of which have a direct impact on the property value and yearly return. Stock investing, in comparison, offers little control for investors and places overall stock performance in the hands of company executives. For legal reasons, there is a separation between the company ownership and stock owners, so you often only see periodic reports on the performance of the company.
Cash flow. Arguably the most attractive benefit to owning real estate, a steady cash flow creates an income stream unlike any other. This is the periodic (typically monthly) profit recognized by the property owner after all expenses are paid. This is often much more lucrative than the dividends available on the stock market.
Appreciation. Building wealth is often a slow and steady process, but the combined effect of monthly income and appreciation can accelerate it. This is not a guarantee, but under the right market conditions in proven areas, real estate assets can gain tremendous value over time.
Stable. Commercial can be often withstand down economies better than alternative investment options. Housing is a basic human need, and renting is becoming much more common as time passes. This creates a consistent demand for the product, regardless of the economic situation at any given time.
Expensive. Depending on various factors, many real estate purchases can be very expensive and can have a relatively high barrier to entry. This hurdle can often be overcome by joining partnerships or investing in syndications.
Involvement. While control was considered a "pro" for real estate investing, it can also contribute to this side of the list. Ownership requires hand-on oversight and involvement from qualified individuals. This requires a significant investment of time and resources to ensure operations continue to run smoothly and the property remains profitable. For those not wanting this level of involvement, the most common solution is to invest in those that do. This can be done through private partnerships and syndications.
Cash. Ownership of real estate assets can offer much less liquidity than other investment options. Depending on the deal itself and the business plan, cash can be tied up for many years until you receive a return. Quickly liquifying your investment may not always be a feasible option, especially when invested in a partnership or syndication.
Network. Real estate is all about who you know and what you can offer. Very few people and entities control the majority of the assets and good deals. It can be difficult to find success in this arena until you build relationships with the big players. Luckily, there are many networking opportunities out there that allow you to create these relationships.
Fraud. There's a lot of "gurus" out there and gimmicks that claim they can make you the next real estate millionaire. Sometimes it can be difficult to know who to trust.
Unforeseen Issues. Sometimes things happen that you have no control over. And as the owner of the property, it's up to you to take care of it. From broken water lines to natural disasters, and most recently the novel coronavirus, these can present major challenges that you need to address quickly and efficiently or you'll face potentially catastrophic losses to your bottom line.
Ethics. While we're in this for the right reasons, many others aren't. There are a lot of bad landlords out there, with no respect for their tenants or community. This makes it even more important that we continue to purchase and manage property in an ethical, fair, and just manner, so that we can make a difference in this industry.
Hopefully this article helped give you a quick understanding of the main pros and cons of real estate investing. As always, if you have any questions or concerns please feel free to reach out.