Invest in Real Estate? Are You Crazy?
I received a comment from a reader who pointed out an apparent inconsistency in my last post, “Why Invest in Real Estate,” where I discussed how real estate is a great investment vehicle. The reader pointed out that in an earlier post I stated my belief that real estate values may not re-gain their high water mark values of the mid-2000s for another decade or so. It is true I did make both these statements. In this post I will address this question and add some additional comments to provide some additional context to my previous post on investing in real estate.
In my most recent post on real estate my goal was to explain the basic mechanics of real estate as an investment and all the potential benefits that accrue to the investor. The last post was only meant to be a general discussion of how real estate investments work but not address timing. There is a right time and a wrong time to buy real estate.
The same is true for any investment. Stocks, over the long term, are very good investments. However there are good and bad times to buy stocks. For example, in 1999-2000, when stock valuations routinely had P/E ratios as high as 40, it was a bad time to buy stocks. In late 2002 and early 2009 when stock P/E ratios were closer to 12, it was a very good time to buy stocks.
It is no different when investing in real estate. In the mid to late 1990s, the time was right for investing in real estate. However from roughly 2003 to 2007 real estate was obviously over valued and thus was a bad time to invest. Like any investment, it is important to understand the mechanics of real estate as an investment. However, you must also know when the right time to make the investment is. I will explain a simple process on how to know when it is a good time to invest in real estate in a later post.
I also received a comment regarding my last post on the example I used to illustrate the benefits of real estate. A reader wrote that it is impossible to buy a $300,000 property that rents for $1,800 per month. Most $300,000 properties where he lives would only rent for about $1,000 to $1,200 per month. It can be difficult to find a reasonably priced property that commands high rent, but it is not impossible. I know because I have done so myself. However, real estate investing is not easy and the economics of real estate investing are certainly better in some areas than others.
For example, if you live in a resort town where the local economy revolves around tourists who come to the town for one week vacations every year, then the real estate tends to be very expensive relative to the earning power of the local residents. This is because in resort areas property owners tend to be high income 2nd home owners from out of town who rent their properties out to vacationers for a little extra income. In a resort area a $1,800 per month rental home may cost $600,000 to purchase. For this reason resort towns are generally not a good place to invest in real estate. Alternately, if you live in a town where all the businesses have moved away and unemployment is very high, there may not be anyone in the town who could pay $1,800 a month rent for any house. Many areas of the country are currently experiencing this problem. The best place to invest in real estate is where the local economy is doing reasonably well, i.e., low unemployment, and home prices are set by the income levels of the local working population.
All my real estate investments are in the Washington, DC area. This is a very good area to invest in real estate because business is good and unemployment is low (must be due to all the government bureaucrats). But even in my local area, before I purchased an appropriate investment property, I had to look at and evaluate dozens of properties before I found one that was even worth making an offer to buy. Most properties do not fit the strict requirements that make a good real estate investment, i.e., the price of a property and the market rental rate is in proper balance. But they do exist. You just need to search for them.
Another area I have been asked about that I want to comment on is the “Pay to Learn” real estate industry. This is the advertisements you frequently hear on radio or see on TV for companies marketing instructional real estate courses that claim to make you an instant expert in real estate investing. Many of the people in these advertisements make claims like “After 6-months of using Ed & Betty’s real estate course, I have bought 14 investment properties and now have a net worth of over $1 million, and I did it all with no money.” There were similar offerings when I started investing in real estate in the 1980s. I even went to a couple of these “real estate seminars” myself as I wanted to learn as much about investing in real estate as possible. However I had one big advantage over most of the other people in these classes; I had already done some real estate investing before attending the class. So I knew to ignore the outlandish claims.
I am not going to tell you that these real estate classes/courses do not have any value. In fact, if you know nothing about real estate investing, and you want to learn a fair amount quickly, and don’t mind paying the fee, these courses can be helpful. In my opinion, the biggest drawback to the “Pay to Learn” real estate courses is the “hype.” The course marketing makes it seem like real estate investing is easy and that everyone who attends the class is achieving incredible results. When you attend the “Intro Class,” they may show videos of people who took the course 12 months earlier and now are retired in Hawaii or some other exotic location. This marketing approach obviously gets people to sign up, but it also sets people up with unrealistic expectations. Many people get frustrated and lose interest quickly if they are not an immediate success. I am here to tell you that you can become wealthy investing in real estate, but it takes a lot of work and it takes many years to accomplish.
It is also possible to get the same information from the many books written on real estate investing. I accumulated most of my real estate knowledge (in addition to learning from investing mistakes in the real world) from books. If you are interested, a couple good books on the subject are Investing in Real Estate by Gary Eldred and What Every Real Estate Investor Needs to Know About Cash Flow… And 36 Other Key Financial Measures by Frank Gallinelli. Both books cover all the real estate investment basics in detail as well as advanced topics.
Real estate certainly is going through some tough times. In fact real estate values may go even lower in the next few years before they go higher. However, this does not mean one cannot start preparing for future real estate investments. For example, you can start educating yourself on the details of a real estate transaction, become familiar with local laws that apply to landlords and rental properties, and start the process of becoming familiar with the property values of your local area. Last, but not least, you should start saving money outside of your retirement accounts to use as your down payment for the purchase of your first property. In today’s world the beginning investor will not buy real estate with “No Money Down” as some pay to learn classes claim.
If you are in your 30s or 40s, I think it may actually be a good thing that real estate values may remain low for several years as this gives you time to get your real estate preparations in order. Then you can take your time looking for the right property to buy. After all, as I talked about in this post, when investing, you want to do the opposite of what everyone else does. One way to follow that strategy is to buy real estate when there is a lot of supply on the market and no one else is interested in buying. That is what I did in the 1990s and it paid off handsomely for me. In fact, without my real estate investment income supplementing my other retirement income, I would likely not have been able to retire before age 65.
My next blog post will be about the biggest mistake people make when investing in real estate.
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