The fallacy of Real Estate investing (from someone who's done it for 20+ years)
My wife & I have owned residential rental real estate properties in two different countries since the late 1990s. There has been a pretty consistent market trend that comes after a stock market collapses (or massive correction) when investor money moves out of equities and into more "safe haven" investments. We saw this happen after the 2001 Internet DotCom crash, and I expect we'll see this again soon.
The reality is that the DJIA is way overpriced. Its being funded by cheap interest rates which was brought on to hack the financial system against the economic collapse of the 2008 Global Financial Crisis. If interest rates were normalized, we would likely see a more consistent, lower priced market and less likely that it will fall from the great heights its likely to fall from. Its not a matter of IF here. History tells us that its a matter of when. But there has never been a time in history when the S&P has been this high, meaning that its going to fall from a greater height than ever before.
The coming boom in real estate
Before I go further, I'm telling you my own feelings for my own investment portfolio here. You make your own decisions with your own wealth and good luck. This is not financial advice because I'm not your financial adviser.
When markets correct or collapse, its likely that we'll see money move to where its treated best. In chaos, that typically is Gold & precious metals and real estate. These days it probably will also include crypto-currencies, but with the massive swings in value in that space, its not likely to be considered a safe haven asset. So I'm thinking its likely to be Gold & Real Estate.
Having been a Real Estate Investor for decades, I can tell you that its not all rainbows and unicorns.
So many of my friends in the Financial Independence (FI) community see owning rental property as a way towards escaping the rat race of financial enslavement. Sure, it can be, but I've been through the good & bad times with this and I can tell you that being woken up at 2AM by a tenant who's water heater has burst, or trying to evict a tenant who hasn't paid their rent while vacationing in Italy with the family, makes you really have to be committed to real estate to see it through.
And that is the key to making this work. You have to be patient. You have to be willing to see it through for at least 10 years, if not 20.
The downside of being a rental property owner
Why? Because as a property owner, you have bought a fixed asset that can't move. Its there - touch it, its attached to the ground. You can't pick it up and take it with you. You are anchored to it. Sure, you can hire a property manager to deal with it, but the reality is that you are a target.
The real estate industry has been around a lot longer than you have and they know how to suck out the life from any property investor like treating them as a cell in the Matrix.
Consider that this is an industry (at least here in Arizona) that feels it is OK to charge you 6% of the retail price of a property when you sell it as a "commission". If you sell a $800K property, you are going to make brokers & selling agents $50K richer. From a simple sales commission. Do you know just how hard it is to earn that money?
And you are going to make the government richer with long term capital gains tax on the sale. So kiss away another 15% or so of the sale profit. By the time all the leeches have taken their pounds of flesh, what you are left with you can supposedly keep. But did the value of the $ that you used to buy it remain the same from the day you bought it to the day you sold it? Probably not. Did you have to fund the property over its life time, with repair, fix and refurbishment costs? And do you get that back? Unlikely.
And during the ownership you are dealing with tenants that think you are a POS and out to stiff them. Its wonderful to live in the illusion that this doesn't happen, but landlords are not popular people. Welcome to the dark side, future real estate investors. You won't be liked. When the tenant can't pay their rent on time, your mortgage bank, HOA, City sales tax, etc. still want to be paid on time. The onus is on you to make good with these obligations, and you are relying on tenants who probably don't have the fiscal resources to keep you whole (or the interest to do it). I mean when it comes down to buying Christmas gifts for the kids or paying you, you come out #2.
You have the legal obligation to account for everything, file the right taxes, forms, paperwork, etc. each month. If you have to evict a tenant (and unfortunately this happens more times than it doesn't with lower income properties), you will become best friends with your legal team and help fund their new Lambos. You will be paying for process servers, lawyers, court fees, etc. because your tenant can just bail on you and leave you cleaning up the trashed place, repair costs and turning it back into something the next tenant wants to rent. You pay. Period.
Does this sound enticing? Nope. Its not. Its a dirty business. If you want to shield yourself from much of this, you could hire a property manager. But my own experience shows that we can rent a place 10x faster than a PM can. And get better quality tenants. Why? Because we give a damn. Because we are motivated to do a better job because we own the property. We will do the right background checks. We won't just rent to anyone because they have a warm body. Trust me, when you have evicted drug dealers, prostitutes, gang members, etc. from properties, you know just how deep you have to do forensics on them. Property Managers won't look into someone beyond a simple FICO score, and you will end up paying for this. I know that a lot of civil liberty people will cringe when I say this, but past behavior is a strong indicator of future behavior and if you are a real estate investor, you pay.
Again the reality is - you pay. You are not a moving target because your building is not a moving target. When it comes to financial extortion, they go after the static target because its easy. I'm talking banksters, governments, etc. But also all the people on your "team". Trust me - there is no TEAM. These are people who's income relies on extracting as much wealth from you in order to pay their bills. Maintenance crew, lawyers, real estate agents, tax officials, etc. They all want a piece of your action.
Is there any light at the end of the tunnel?
Yes, but my own personal experience shows that this only comes after at least 10 years. It really comes down to why you are doing it. There really can be only one reason.
Its not about "cashflow" as many of the schemes out there trying and tell you. You won't cashflow a property unless you can extinguish the expenses from it. And that's hard to do, particularly early on.
Its all about LTV (Loan to Value). If you buy in with a decent downpayment, you will reduce your mortgage costs on the property. Then you might be able to make the numbers work, or at least break even. But the type of mortgage you get for the property matters. I'm a firm believer in 15 year fixed mortgages. Why? Because it forces you to do more to get the highest rents and to re-invest the rental income back into your own investment. And you are in this for 15 years. Don't try and sell the property until then. You want to have something that shows a big time net worth addition to your wealth here, and you want it to be growing slowly and organically. Then you will have a great chance at seeing the true light at the end of the tunnel.
So before you all start telling me, "Well I can buy & flip property X", consider that this only works when you buy low and sell high. The times that the market trends support that are limited and you better be a professional who gets to see that, and can keep the maintenance costs under control. Sure, many can do that. But the new generation of investors who haven't seen a bull & bear market (at least not to the level we saw in 2008) should be cautious about the risks here. When it comes to buying real estate, the buck stops on your desk. Quick decisions are usually wrong, and you should go with what you know. Not what you read somewhere, or your buddy at work told you at the water cooler one day.
Its coming
The time of the "real estate boom" is coming. It comes in waves and we are due for a DJIA correction and a move of money into real estate. When that happens, you will see the number of "Fix & Flip" TV shows doubling as more and more people think that they can make millions in real estate. Sure, you can. But it will take 10-20 years. If you are in this for the long haul and your life is stable for that period of time, you might be one of those millionaires. But if you have a history of not sticking to anything for a long time, real estate investing might not be for you.
Good luck.
This was informative and well-written. I agree, you've got to be in it for the long haul if you want to earn any cash. Unless you're looking for a quick flip, selling a house brings with it closing costs, realtor fees, capital gains tax, income tax, and maintenance and upgrades.
To say nothing of damage from stupid tenants. I'm not an investor currently, but have done it in the past. It is something you can do for a couple of years if you pick at the right time, and get good tenants.
My first rental turned a $45,000 profit after 2 years, and we never had to pay much of the monthly mortgage. Down payment was minimal. Repairs were minimal. But it was a unique college town where the market was hopping. And our duplex was decent compared to the many that were not.
We did not need property managers, as the tenant market was saturated with fairly decent students, and we were nearby.
I don't know, I'd probably do it again. If I had the capital to put down. But I think we did get pretty lucky. There is a risk with things going wrong with the house, the tenants, and the market. It's not as easy as Robert Kiyosaki says!
Thanks for the reply. I own 23 properties, so my blog & observations are based on a larger statistical base for measurement than one property. The problem is that most REIs go into this with stars in their eyes and don't realize the true market until they are too far in to back out. That's when losses occur. Your profit numbers probably don't reflect the cost of the sale, the capital gains tax on the proceeds, the origination costs of the original mortgage, any other closing costs, the costs to do the property up to get it ready for sale, etc., etc. When you deduct all of this, the numbers look very different and yet these "devils in the details" hide away and distort the story (as you accurately say) told by the likes of "Rich Dad" or other 3AM infomercials. This is a long term business investment and most REIs find the first few investments they make don't return anywhere near the profit levels they were hoping for. Its like VC investing - you have to invest in 10 ventures, to find the "Google" level opportunity. You might get lucky on #1, but there's a 90% chance statistically that you won't.
That's true. That number did not include income taxes, property maintenance, closing costs or mortgage and realtor fees. However, we had a zero down for being first time buyers within a certain income bracket in that state. And as I recall, we didn't have to pay capital gains as we lived in the upper half of the duplex for a couple of years. The maintenance was minimal. A few hundred total. And the income taxes were also minimal as I was a student and my then husband was not earning much that year.
So, all told, I think we came out pretty well, but just looking at it, we were pretty lucky. We knew all these factors going in, though. We knew the market, and the profit/loss risk we ran. And a lot of first time investors don't.
I'm currently in a place that has appreciated very well within the first year. We had some unknowns this year and were thinking of renting, but we saw the market trends for our area, and were aware of some other demographic changes within the city that would also boom the real estate from a new industry being brought to our town and an influx of families needing a place to live. So we decided to buy low and live here for awhile, then sell down the road. Again, it's always a risk, but we have a mother-in-law suite on the house that could rent if the mortgage were to go upside down for any reason.
As far as investing in properties, I probably wouldn't want to do it for the residual income as you do. I am more interested in restoring old homes. That's what I'd like to do some day. I'm a big turn of the century freak. I get sucked in to that stuff and drool over fixing up all the old sad homes in our town. There's one I have my eye on, but it would require a good $250,000 capital just to restore it. It's got a likely $750,000 profit margin, all told. So something like this would be rewarding financially as well, but I would not be interested in doing it unless it brought satisfaction on another level because real estate work is a huge risk, and a huge tax on the person if they are not up for it.
My brother flips for a living, and has his ups and downs. But mostly ups. I think it's a great industry if you're up for it, but like you say, you gotta be up for it. It's NOT a get rich quick. Again, we were lucky on the first one. All things lined up.
"I know that a lot of civil liberty people will cringe when I say this, but past behavior is a strong indicator of future behavior and if you are a real estate investor, you pay."
Definitely agree here. Had a few tenants who were a pain in the butt. Should have dug deeper when looking into their rental history.
At the moment, I find it hard to believe that Real Estate will continue to rise at the current pace, even if the stock market crashes. Repealing Dodd Frank may give the market a boost, but the market in San Diego seems ridiculously hot.
Thanks for your comment. In regards to property in your neighboring state to the east, the market rises here are dulled compared to California. This used to be the fastest growing real estate market in the country (pre 2008) but was also one of the worst hit with foreclosures, etc. in 2008. Consequently there is still a "once bitten, twice shy" approach about Phoenix. Probably Las Vegas too. Developers are not and have not been developing new property here, so there is a supply/demand problem forcing rents higher.
Surprisingly though, the market value of real estate properties hasn't risen that high. We are still seeing higher end homes at about 80% of their 2007 high price points, and low end condos and multi-unit properties about 85%. There is a lot of headroom here for rising prices.
Blackstone are the largest holders of residential real estate properties, and they are funded by hedge fund investment from Wall Street. Its not Dodd-Frank that will have a huge impact on that, as that might only open up lines of credit to lenders. For those large scale buyers, they will be more able to acquire properties if the equities market takes a dive, which is a likely scenario in the near term. Also we've had a lot of Canadian and Chinese investors come in to purchase properties with cash here, but that seems to have dwindled.
So it might well be that in the California market, the rising real estate prices has made that less attractive. But consider Nevada or Arizona and you might find some interesting differences in the economic numbers. Additionally AZ is a great place to be a landlord because of the tenancy statutes here, that provide quick eviction proceedings unlike in CA. I believe Utah & Colorado share similar statutes but it clearly favors out of state investors to bring their money into the state.
I'm a property manager (and also an investor and developer myself), after managing thousands of properties I can see that the number one thing that goes wrong in tenants is financial difficulties. Very few properties get trashed and used as drug houses but there is a greater risk (5% in fact) that well screened tenants will face some financial difficulty and abandon the house - these stats are based in South Australia. With absconding tenants there is usually a clean up required but usually very little property damage.
I agree that PMs do contribute to problems, to vacancies and also become part of the problem while being paid to be part of the solution.
The single biggest downfall I see in property investing however is being unable to qualify for a pension in aging years. I have clients who are elderly and in nursing homes who own property portfolios. They are unable to get any kind of assistance either medical or nursing home costs or anything, they need to be completely self funded.
That means that their properties do not get property maintenance done, they are the most run down properties resulting in less rent down the track and therefore less for the elderly landlords to live off and pay their nursing home with. There are huge problems when expenses like replacing hot water services come up.
Their room mates however in the exact same nursing home in the exact same bed eating the exact same food and getting the exact same care, who have no properties, have everything paid for them through a pension given to them for free by the government for the privilege of never having invested in properties while they were younger.
I'm not sure what the solution is, but it really is an unfair system and punishing towards people who enjoyed their money less and purchased properties instead. As a property manager, seeing this actually breaks my heart.
I may be somewhat unique in being able to compare South Australia with the USA, as I'm an ex-pat who was born in Adelaide and owned 3 houses in Mt. Barker as rental investments. Against that, I've owned a couple of dozen properties in the USA (where I'm a dual citizen). Its an interesting comparison.
The respect for a one's home in Australia is far higher, IMHO. This comes from experience. People tend to try to do their best when it comes to their homes in Australia. Hence your comments about problems when people get into financial difficulty are correct. However the problem is that the govt of Australia and social culture puts caps on rent amounts that makes it next to impossible for landlords to make money out of pure rental income. The interest rates are not fixed, but float as variable rate interest loans that are tied to central bank policy. Many areas have rent restrictions either by edict from govt. agencies or simply because of poor landlord representation. PMs will dictate to a landlord what they "can" charge in rent, rather than doing more work and getting better rent returns. This results typically (and this is from my own personal experience) in rents being under valued and landlords ending up negative gearing a property as their only way to see some revenue. In contrast to this, the real estate market in that region has grown at extraordinary levels, where I've made 3x times what I've bought properties for as equity increases after 5 years. However this was an anomaly as property values are so far overvalued now that Australia is ranking in the top 3 priced real estate markets in the world, and the 2008 crisis that the USA went through was shielded from Australia by way of a resources boom. That boom is now over, and the chance of a full blown destruction of property value in that region is extremely high. I would never buy into that market due to the restrictiveness of maximized rental income combined with the high rate of risk of the market imploding, along with central bank rate rises that occur far more aggressively than in the USA.
In the USA by comparison, you have each state dictating rental statutes, with some (e.g. Arizona) providing landlords with a simple "robo-lawsuit" system to evict tenants, which typically means if a tenant is late on their rent on the 1st of the month, they are evicted by a court officer (ie. police officer with a gun) by the end of that month. Compare that to Australia in which evictions can take more like 3-6 months. Again, the landlord is holding the bag during that time - no rental income and a trashed property where the tenant has plenty of time to get out.
As a businessman, I would never accept that as a viable business proposition where tenants rights far outweigh the rights of the landlord. It clearly makes it a far less attractive market to purchase rental property in.
Maybe you have a way to address these issues, and I'm all ears. If the market has changed, rental tenancy statutes are more favorable to landlords, and tenants are held to actually pay their rent on time or be evicted in a short time frame, then I would say its a market I would consider re-entering. But after coming back from a trip there last year, I didn't see any indication that any of this has changed.
I realize in writing this response that I neglected to state the importance that any landlord needs to have in understanding the detail of the residential tenancy statutes in their region because they will quickly become forced to understand law in terms of enforcing their rights to evict tenants and return a property back to a positive rental experience quickly when the tenant defaults on their obligations.
I was thinking a bit further about your comment, and there are so many things wrong with this. First, a warning to any wannabe landlord out there.... Depending on the region you are renting in, either the govt or social culture will stick you with the responsibility of things that have NOTHING to do with property investments. As xeniaioannou states, she feels bad about the unfair nature of the elderly not being able to pay their rent, etc. And yet manages 1,000+ properties.
This is where new landlords fail. The reality is that your obligation between the property owner and the property renter is a simple contract - the lease. Nothing more. You can pretend that we are all part of some social fabric here and we have to do the right thing by the tenants, etc. But the responsibility of churches, liberal govt policy, etc. is NOT the responsibility of the landlord. Unless you are willing to be the bad guy here, DO NOT get into rental real estate investing. You will be chewn up and spat out in the first 90 days as your tenant starts to make you responsibility for their own failures. Sure, people fall on hard times. Its ok to give them a break - ie. pay me tomorrow, etc. But the bank isn't going to give you that break. The govt isn't going to give you a break if you are late on your sales or property tax payments. The power company isn't going to give you a break, etc. You are the meat in the sandwich and unless you are wiling to be an a-hole you will be destroyed by it.
Its another reason that people fail in property investing. I remember going to a party at an acquaintance's house in which they said they had bought a rental property, but they were going to sell it at a loss to get out because they couldn't deal with their tenants. The reality here is that they trained their tenants to act the way they are acting by not being the bad guy. You give them one break, they will come back at you time and time again and you will go insane by this and likely sell off the property for a loss. You have to be an a-hole in order to make this business work.
If you don't understand this, and don't accept it, don't get into real estate investing for rents. There is a reason why people have to rent, and most of the time its not because they fell on hard times. Its because of a continual pattern of decisions made in their lives where they didn't take personal responsibility for things and constantly offloaded that failure to someone else.
Landlording can be a very profitable and valuable thing to do but you have to have strict rules and lines you don't cross. The residential tenancy statutes in your region defines the behavior of landlords & tenants and its up to the judge to determine who is complying and who is not. Period. Its not your responsibility to be a charity and if you are getting into the landlording business, then you are getting into the business first. That means run it like a business and run it for a profit. Not as a drain emotionally on you, and not that you are the willing victim to assume everyone else's problems.
I realize this might come across cold, but its fact. Don't get into property investing until you are willing to be hard lined with this. If you are not, THIS BUSINESS IS NOT FOR YOU.
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I believe that, on the contrary, when absolutely the entire world economy is unstable, investing in real estate is the only way to invest your money reliably. Now we have turned to https://www.sjonessurveying.co.uk/newcastle-surveyors / to find out the exact parameters of the plot we plan to buy since the real estate value is rapidly increasing and money is depreciating. Therefore, I think the most reliable way to save money is to invest it in something stable like real estate. But you need to do this carefully and consider all the details.