It’s obvious why investing in real estate is appealing. In its simplest form, it’s a direct way to make good money, and you don’t need any specialized education or training. And the Southern California real estate market is booming. As it stands right now, it seems like you can’t make a wrong move if you invest in real estate.
But that’s when you only hear the success stories. People putting up their house as collateral and taking out a loan, and then losing their investment doesn’t make the front page. That’s not to say that you shouldn’t invest in real estate. However, you should know the pros and cons of investing in real estate so that you can make an informed choice and do what’s best for you.
- 1 The Pros of Investing in Real Estate
- 2 The Cons of Investing in Real Estate
- 3 Is Real Estate a Good Investment?
Investing in real estate can be very rewarding, even excluding the financial aspects. You can help the local residential market and grow the community while providing homes to people who deserve them.
Community-oriented companies like SleeveUp Homes have made it a business model to help people that have trouble selling distressed properties. This functions both as a solid business strategy and gives back to the community, so real estate is not only about making money but has other rewards too.
These things won’t end up on a savings account or a bank statement, but you’ll know. However, investing in real estate is, above all, a business, so we’ll focus on the financial aspects. After all, you won’t be able to help others if you’re not in a position to help yourself first.
One of the main pros of investing in real estate is that the success of your investment largely depends on you. There are still outside factors that are not under your control, but your decision-making has a larger effect than with other types of investments. You don’t have to sit in a board meeting and hope they listen to your advice and come to the right decision.
It’s up to you what property you’ll invest in, the improvements you’ll make, or what tenants you’ll allow. This does also mean that you bear the burden of bad decisions. But having a large amount of control over the success or failure of your actions is a pro.
A major positive of investing in real estate is that the rise in the value of a property usually outpaces the inflation rate. Unless something seriously unfortunate happens (like when the housing bubble burst in ’08), your investment will be worth more as time goes on.
Plus, as property is a real, tangible asset, its value can never go down to zero. Unlike investing in stocks, where your investment can become worthless, real estate can never depreciate to such an extent. Even in the event of a crisis, if you can hold on to it long enough, real estate will appreciate over time and you won’t lose money.
We’ve mentioned inflation in the previous section, but we should expand on it as it’s important to the pros and cons of real estate investing. In simple terms, inflation means that the purchasing power of money decreases over time. So, you can’t buy the same thing for a dollar today as you could in the ‘80s.
Inflation rates are simply the percentages at which the prices rise over time. Inflation is inevitable in a free-market economy, and there’s nothing you can do about it. But that’s not an issue with investing in real estate.
As the cost of living goes up, so does the rent your tenants will pay you. And the value of your property appreciates, usually at a higher rate than the inflation rate. Even if your property appreciates at the same rate as inflation, your fixed-rate mortgage remains the same, so you’re still making money in the long run.
This one is simple. Once you’ve invested in real estate and you’ve got everything set up, you can rent your property. You’ve now got a steady source of mostly passive income (excluding making small repairs, finding tenants, etc.). You have more free time to focus on your other job or spend time with your family, while the cash flows in.
When you invest in real estate, you leverage other people’s money to grow your wealth. Let’s say that the median price of a home in Southern California is $600,000. You take out a conventional loan to purchase it and make a down payment of 20%, plus closing costs of around $20,000 (there are many variables in practice, but this makes the math simpler).
So, you’re investing $140,000 of your own money, but have control of an asset worth $600,000. You decide to rent it, and now you’re renting a $600,000 home instead of a $140,000 one. You can use the rental income to pay off your monthly installments and build equity.
The value of the property will likely appreciate over time, and you’re building equity, which all leads to an increase in your net worth. Then, you can tap into the property’s equity to finance improvements, further increasing the value.
The tax benefits you get when investing in real estate are often overlooked, but unjustly so. First, you may be able to deduct expenses relating to an investment property – things like property tax and insurance, mortgage interests, and management and maintenance fees.
If you own a rental property, you can deduct depreciation over the long term. You can also deduct the operational expenses of running a business. However, keep in mind that this mostly applies to an investment property and not always to owner-occupied real estate.
In theory, investing in real estate seems like a simple solution to build wealth. Of course, this is if everything works out as planned. There are both pros and cons of investing in real estate, so you should be aware of the risks before you decide to leap.
The saying – it takes money to make money – is true for investing in real estate. First, you need to have enough accumulated capital to be able to make a down payment and pay for the closing costs, and then pay for improvements to maximize your income from renting.
Then, you’ll need to pay monthly fees, besides your mortgage. You’ll have to pay property taxes, insurance, and maintenance. If your tenants miss a month or two of paying rent, and you’re counting on that money to cover the costs, you could be in trouble.
You either need to have enough money to cover the costs out-of-pocket, or have an exit plan in place. And selling the property to cover your expenses is far from the best option if you want to make money by investing in real estate.
Put simply, it takes time for your investment to pay off. Building equity and raising the value of your property is an ongoing process, and it won’t happen overnight. Yes, you have assets that you can sell, but you won’t make any money if you have to rush it.
First, you’ll need to understand the rules and regulations that apply to your property. Then, if you want to rent, you’ll need to dip into marketing and find good tenants. And you can always expect to receive late-night calls for repair requests.
If you have ideal tenants – ones who pay on time and don’t damage your property – property management won’t be too difficult. Conversely, if you have problematic tenants, you can easily end up having to go to court to deal with them. And that’s an investment of both time and money.
You can always hire a property management company. But that also means taking the time to find a good property management company and changing companies if you need to. And, of course, outsourcing property management cuts into your bottom line.
Then, things can happen that you simply can’t control. When the housing bubble burst in 2008 is the clearest example. Some investors were able to foresee it and managed to sell in time, but they were few and far between.
You can think of it as an earthquake or wildfire – you’re lucky if you get out. Such a catastrophe doesn’t happen often, but nobody expected it the last time, either. You could see the value of your property plummet and lose your investment through no fault of your own.
Investing in real estate has other risks attached to it. You could make a wrong assessment and buy the wrong property at the wrong time. If you buy in a high vacancy area, you could see no rental income for some time, but you’d still need to make your monthly payments.
You could also be held liable for accidents that happen on your property. You could lose your job and not be able to even make your mortgage payments. You could get stuck with renters who know how to game the system, putting any potential income on hold for months. Investing in real estate is not as simple as it may seem at first glance.
To sum it up – it can be. You can increase your net worth through capital appreciation, have a steady source of income, own assets that you can leverage, and contribute to the community. But you need to be very mindful of the risks involved and understand the pros and cons of investing in real estate before you leap.