As many readers of The Money Vikings know, I primarily work in the realm of real estate. For centuries real estate has served as an attractive asset class that can preserve and grow wealth.
As we continue on our journey to financial independence or perhaps “early retirement” (FIRE), we will need to choose several investment vehicles. Real estate can be a classic and time tested choice. In other words, how will we build wealth and create “passive” income machines?
It may be a stretch to call real estate a “passive” investment. One thing I like about real estate is that it is a hands on endeavor involving a physical thing, with people, capital, projects and space to manage pretty much on a regular basis. Sure, it does not involve going into an office every day and sitting in a cubicle, but there is plenty to do that is not “passive.” So before considering, do research and know what you are getting into.
Why Real Estate?
Real estate for me is an interest and a kind of passion. I really like it. I value order, good design, well maintained properties, providing shelter, the value of spaces, capital investments, cash flow, appraisal processes, etc.
I know that sounds nerdy, but we should pursue things that we find interesting in one way or another in my opinion. People make money off all kinds of pursuits and passions. The bottom line here is that I would only suggest someone invest actively in real estate if they have some kind of interest in the whole thing.
Many, many ways
Another neat thing about real estate is that there are dozens of ways to invest and work in this industry. Some take huge amounts of money and time and some can be started for as little as $100.
Properties in my opinion are a kind of living thing. They take constant maintenance and attention, care and feeding, etc. One thing I feel though is that property and humanities utilization of it is not ending ever. Yes, things and conditions change, but real estate is here to stay as far as I can tell. Wait until we plant a flag on Mars and claim ownership.
Time tested wealth building vehicle – Real Estate
As mentioned earlier, one will need to choose which wealth building “vehicle” they will utilize over the years. Saving will never cut it alone. Saving is a vital and important skill and habit, but it will not build wealth. The problem is that we will not make enough in a 30 year career and life will continue to get more expensive. Almost none of us are high paid athletes and movie stars or members of a royal family. The average worker with a good job in their lifetime will make about $1.8 million. Even if someone is a super saver and saved 20% of their salary the whole time they worked, which is 1% of the population, they would have $360,000 to live on for the next 30 years.
$360k is certainly a lot of money, but in 30 years it will not be if that money sits in a savings account. As inflation rises that money will be “worth” less and less in terms of buying power. From the 360k one could withdraw $12k a year for 30 years. Certainly not living in the lap of luxury by any means. The good news as we know is that there are many options for investment vehicles. There are stocks, index funds, bonds, CD’s, small businesses, dividends, real estate, etc.
Real estate is a time tested wealth building machine. With real estate the investor makes money off cash flow, tax advantages and appreciation in the value of the property. The appreciation is aided as you pay down the mortgage and build equity. Word of caution, historically real estate does not outperform the broader stock market, so it’s important to choose the market and property wisely.
Real estate is not for everyone – Are you ready checklist
Here is a general breakdown of what I would consider before diving into hands on real estate investing:
A. Does it match your preferred investment vehicles? Is real estate something you are curious or interested in?
B. Do you have the temperament? In other words, are you organized, somewhat handy and knowledgeable, can you work with people and contractors, can you solve problems? Can you manage money, time and projects effectively?
C. Are you financially fit? Like all investing, we do not start with the more complex investing in terms of our overall personal finance picture. Is your debt under control? do you have emergency savings? Do you have general knowledge about finance, investing and banking? Do you have good income, steady employment and insurance coverage?
I see many people dive into investing without any of these fundamentals under control. The fundamentals build the foundation for wealth building, without them the structure falls apart unless a person gets lucky. Do you have good credit is another key question. Real estate typically involves using other people’s money as leverage to acquire the asset.
For most people there only real estate investment is in their primary residence. I know of late financial bloggers and others are trashing the idea of owning a home as not financially sound. I still believe this is a great decision for most people if they keep it in check. The main reason why is that at least at the end of decades of owning a home you have an asset that can be sold or rented out. Paying rent over all those years will never provide access to an asset. In addition, most of the people that argue against owning a home say that one would be better putting the maintenance, taxes and other savings into investments. I don’t think most people have that kind of discipline, they will pay rent and blow the rest.
Real estate is obviously all location based, so it is important to understand and research conditions in your local city and market. Is the economy diversified and growing? Real estate in a one company town that is now defunct and rusting will not go up in value, there will be no demand and unused failing supply. So unless there is some turnaround plan or you can make money renting property to people, probably not the best location to invest in.
Lilly pad hopper
I think I invented the term “Lilly Pad Hopper Real Estate Investing”, at least I hope I did. I am a big fan of real estate investing over the years by buying, moving in for a while, fixing up, then buying another home to move into and renting out the last one. If you did this every five years, at the end of a 30 year career you could have 5-6 properties under your belt. That would make for some pretty awesome wealth building and cash flow, like a second pension or investment account. But keep in mind this will take years of work and management, and is not a get rich quick concept, it is part of building wealth one brick at a time.
Financing & Leverage
There are many schools of thought in terms of financing and the proper amount of money to put down etc. I am a big believer in putting money down. We all know what happened in 2008 after years of lenders handing out massive amounts of money on the street, the house of cards eventually crashed. But on a micro level it increases your cashflow when you put more money down.
Alternatives to Owner Investor Landlord
There are several ways to invest in real estate that have nothing to do with slinging a hammer or doing reference checks on prospective tenants. I have enjoyed the dividends from Real Estate Investment Trusts for many years now. One to consider is Realty Income, ticker “O” which actually pays the rare monthly dividend, which kind of makes it feel more like a real estate arrangement.
REITs are tax exempt vehicles that generate consistent cash flow and pay dividends that keep growing over time. Over the long run, REITs have outperformed the S&P 500 by a factor of 4 times.
There are different schools of thought in terms of where to invest. Some say close to home due to the hands on nature of RE. This may be a good place to start.
But, there is a compelling argument for not investing close to home. You may live in an expensive area with low cap rates, therefore investments are less attractive.
There seems to be a happy medium out there. Some outfits will provide the ability for investors to invest in more favorable markets at a lower hassle for a fee.
I highly believe in making real estate investments close to your local market. This is the area I understand in detail. I understand the culture, the jobs, the growth prospects, the schools, the local contractors, etc. I think this leads to better investment decisions and the ability to check in on a property. Even if you are not actively managing it, it is nice to drive by and put eyes on activity and condition.
Net Operating Income (NOI) and future income stream
A key factor in determining whether a real estate investment is worth it is by analyzing the net operating income or NOI. Don’t let a fancy term deter you, this is basically the potential rental amount based on market data minus the monthly cost of the mortgage, taxes, maintenance and amortized closing costs. In other words, how much profit will you generate each and every month. If it is negative it may not be worth the investment unless you are thinking long term about appreciation of the underlying land and asset. If it is positive you will want to consider whether the profit is worth is each month to you. A lot of work is involved, if you are making $20/month after all that, is that enough?
There are obviously volumes and volumes of books about real estate investing and it can become as technical as you want it to be. In my mind it comes down to a few simple concepts. First of all, you are providing an important product to people. Secondly you own something that is real and tangible and you have some control over it. You have virtually no control over a stock or a company and what it may or may not do. With a piece of property, I can decide to make improvements, market it for different purposes, raise or lower rent, refinance, put in low maintenance landscaping, change colors or styles, etc. These are all active measures I can take to change and improve the property as needed.
Real estate is a calling my opinion and takes a certain set of skills and temperament. Perhaps start small with a moderately priced single family home. See if you like working as a landlord and property manager. It may become one of several investment vehicles and income machines one can build to grow wealth.