Like if it’s not completely clear that you won’t be able to rent it out so that you can cut your losses, and instead you spend years trying and succeeding partially, in the form of occasional short-term deadbeats who trash your apartment and move out without paying the last 8 months of rent while you were struggling to evict them.
From a financial standpoint, it might not be that much worse than what you describe. But from an aggravation standpoint it could be a lot worse.
This happened to me with an investment property. I wouldn’t do it again–I don’t really want to spend money to buy myself another aggravation. I buy and hold index funds and spend my out-of-the-office time committing leisure.
On the other hand I have a friend who’s done very investing in rentals. Certainly a lot of people have made a lot of money in real estate, and I’m probably forgoing investment gains by staying away.
First of all, no. The proper way to measure diversity of investments is based on the asset value, not the amount of your income going into them. And we don’t know what that is for the OP, but based on the little info we have, it’s likely that his current asset allocation is heavily weighted toward real estate.
And of course owning a house doesn’t disqualify additional real estate investment. There’s no reason that the OP couldn’t invest all his money in real estate, and then some. That would simply not be a move toward “diversification”, which is the point you made that I initially responded to, and which remains incorrect.
I mean the worst case scenario is that you end up buying a house that has some kind of horrible environmental contamination and you end up on the hook for cleaning it up, or you get a tenant who injures himself in a way that he can convince a court you are liable for and that overwhelms your insurance.
Those aren’t very likely outcomes, but they are possible, and could result in liabilities larger than your initial investment.
There’s a reason why limited liability corporations are good for investors. You might want to spend a little money with a lawyer to see if you can protect yourself against the actual worst case here.
We had a thread not too long ago about the relative benefits of commercial and residential REITs, (Real Estate Investment Trusts). That would be a way to get involved in real estate without going all in on a single property.
Speaking from my personal experience here: the only way that I was could have transferred a property to an LLC was to own it outright. Banks weren’t willing to refinance to an LLC. (Probably worth verifying this independently, given how valuable an LLC shield is).
If you do own the property outright, an LLC is a very good idea. In fact, if possible it’s probably a good idea to own each of your properties under a separate LLC.
Stepping back a bit: Is there a reason you want to do something different than invest in index funds?
Real estate, historically, has had lower returns than a stock index fund. Yes, there are people who bought houses for a song decades ago and sold them for a fortune later, but there are also people who bought houses in Detroit in the 60s and just abandoned them. Long-term growth is around 1% above inflation.
Is there a reason you want to own one specific property, and pay a manager to rent it, vs. owning some shares in a company that owns a bunch of properties and pays managers to rent them?
One way to “beat the market” as a landlord is to do the work yourself, basically handyman stuff and selection of renters. But if you’re going to hire someone to manage the property, you’re not going to get those gains, so I expect that, on average, you’re going to do worse than just buying a REIT.
I don’t know about you, but my index fund investments have built wealth. They’re worth much more than I paid for them.
The primary way to build wealth is pretty simple:
Spend less than you earn.
Invest the rest in an asset that appreciates or generates income.
Real estate, stocks, bonds, etc. all fit #2. They’re all fine ways to invest the surplus. None of them is a magic ticket that’s going to for sure be the best choice.
I’ve seen some of these types of stats and suspect that they’re very misleading.
Specifically, I suspect that what these numbers refer to is the capital appreciation in the price of real estate, which ignores the benefit of living in them for the duration, or the rental income if it’s a rental, and/or the leveraging effect of (fixed rate) mortgages. I’m very skeptical of the notion that the complete returns of real estate are only 1% above inflation, and if you have starts that purport to show this I’d be interested to see them.
The Nobel Laureate Robert Shiller is not a fan of real estate. I can’t find the graph but in his book “Irrational Exuberance” he shows that home prices have been quite stable for over a century.
You are correct that I was referring only to the capital appreciation (I believe the Case-Shiller index shows something like 0.4% annual growth long-term), and that’s definitely not the correct measure to use here. Sometimes you remember a figure and it seems like a great time to throw it out there!
If you look at returns on REITs, they’re fairly similar to stock market returns on a long timescale. Which is to say: buy real estate if you want. Buy stocks if you want. You’ll get similar returns on average.
But if the OP buys a house or apartment to rent out, is he looking forward to possibly needing to drive 2 1/2 hours out there on a weekend to deal with it? (Perhap repainting between tenants. Perhaps cleaning up after a nightmare tenant.) The OP did mention that he was planning to hire a property management company but if you rely on them for everything, that will quickly eat up any profits from the deal.
I’ve had a rental property for the last 15 years. It’s either been the best thing I had going financially or the worst.
When I was in college I lived there with roommates who paid my mortgage and my utilities and I just had to replace the water heater.
Once I moved away I hired a management company that placed four consecutive tenants from hell in there and not a single one stayed until the end of their lease and each destroyed the place on their way out the door doing more damage then I’d received in rent let alone in excess of the mortgage.
I fired that company and fixed the place back up my new rental company has never had a tenant do more damage then their security deposit and each has either stayed for their full lease or extended their lease at the end. Of course the second company costs less than the first one did too.
My place has appreciated about 60% since I bought it but without checking my spreadsheet I’d say I’m cash flow neutral on it over its lifetime. Of course most of the negative was due to the bad management company and aside from their years I come out slightly ahead of depreciation each year.
Of course all of that is a long winded way to say if you do this spend as much time on your manager as your property because a bad Manger can absolutely ruin your investment and a good one will make it a dream.
Also there are two way to become wealthy from buying rental property one is to buy a busted up place, fix it up and rent it for way more than your mortgage the other is to roll any positive cash flow into purchasing a new property so you get your initial leverage position then use that to get more leverage and so forth (of course if you run into cash flow problems the whole system comes crashing down and you lose it all but if not you can turn 80 in to 8,000 fairly quickly)
I think it would be a good eye-opening experience to be a landlord and have to make judgements on tenants and deal with evictions. However, that’s not for me at this in life. I’d rather put money in index funds at Vanguard for the next 20 years.
Now, my risk and desire to be a land lord tolerance may change 5-10 years from now as net worth grows. But that’s to be seen. Can you make money doing this? Absolutely. Many many people do. But the real question is what are your goals for this money?
Figure out what you want/need the money for. Have a number in mind then work it backwards.
But to do it right, you have to account for your own time in some fashion. Maybe not in the relentless way that a self-employed business owner should look at his profits and effort spent vs. just having a normal job, but your non-working leisure time is valuable now, and becomes drastically more scarce for several years once you have children.
You’re only definitely “beating the market” in a fiscal sense, but is that worth spending a significant chunk of your non-working time to do so?
There are many people who have made big fortunes in real estate doing this, but many of these same people have also lost big fortunes doing the same thing.
Real estate is cyclical and when it turns down, all the overleveraged guys are crushed. Some of these guys have negative cash flow from operations (due to purchases at inflated prices at the peak) and are relying on steadily increasing equity and refis to keep solvent, but even the ones whose cash flow from operations is positive can still get in trouble if that itself changes, e.g. vacancies increase and the like. (If you’re shrewd enough and not too ethical, you can make money on the way down via fraudulent short sales - I’ve discussed this in a prior thread - but you need the above qualities, and I believe this applies mostly to mid-level operators in with a lot of small-sized residential real estate.)
[I know a guy - I don’t know him personally but my wife and I know his daughter and SIL - whose first business venture was one of these seasonal farmer’s market/fruit-stand businesses, and who then went into real estate. He started small but kept leveraging to the max and got bigger and bigger, and at one point was easily worth in the hundreds of millions of dollars. But then the cycle turned and he was - as always - in middle of his biggest venture yet (a massive development on Staten Island) and everything fell apart. (Guys like this are somehow richer than you and me even after their businesses go bust, but he’s nothing like he once was and his lifestyle has taken a huge hit etc.) Anyway, the point is that someone supposedly asked this guy why he didn’t just stop before his last deal and be satisfied with the vast fortune that he already had. And he replied “if I had that type of mentality, I would still be selling fruits in the market”.]
Very true. I live in NJ, and for a while the way many people were getting into real estate was residential RE in Trenton (or even Camden, for the higher-risk people). The thing was that you could buy single-family or two-family homes for about $60K (even cheaper in Camden), and at that time banks were letting people buy RE with 5% down and PMI, which meant you could buy a 1-2 family house for $3K plus closing costs. This was ideal for entry-level people looking to break into the market.
The thing is that for many people this was reassuring on a sort-of psychological level. The idea of a house for $60K sounds like a steal of a deal, and sounded like the type of thing that couldn’t possibly drop further. Plus, at those prices the cash flow tended to be very favorable on paper.
But that was very very misleading. Fact is that the prices could drop quite a lot, and did. At some point all these people who bought houses at $60K were stuck with houses that were worth $20K-$30K (this is a few years ago - I don’t think that market has recovered but I’ve not been following it of late. You don’t hear so much about it these days, and one relative of mine who made and lost a lot of money in Trenton real estate is now an exterminator :).) And as for cash flow, well that was misleading too. The numbers were extremely favorable if 1) you actually had a tenant, 2) who actually paid the rent, and 3) who didn’t destroy the place. And while such tenants existed, they tend to be in short supply in places where single-family houses are selling for $60K. So basically it lasted as long as the equity kept going up and collapsed thereafter. A few years ago a lot of people were unloading much of this RE to foreigners who were ignorant of local RE conditions and how the market worked.
My father once asked his father what’s a good business to make money in. He responded “if you know what you’re doing you can make money in any of them. And if you don’t know what you’re doing you can’t make money in any of them”. But there’s also some luck involved as well.
Hell there’s property in Anacostia and PGC for that price. But there’s probably a reason it’s so low.
My point about cville was the radius, which encompasses everything closer. And cville is 2.25h actual driving time from Cleveland Park, DC. Just not on a Friday afternoon. Orange, Culpeper, etc. counties are all closer. Fredericksburg is on the VRE.