I love real estate investing, but it comes with some downsides worth considering. I'll highlight the many pros and cons of real estate investing worth considering.
10 Important Pros and Cons of Real Estate Investing
I've been looking at real estate assets for over 10 years now. It's one of my favorite asset classes. It isn't for everyone, however, as there are alternative opportunities that may yield higher returns.
I use Personal Capital to track my net worth and assets. It's been a great tool as I can link my investment properties to my account to track net worth growth.
I don't include the actual cash flow from my real estate properties into my net worth as I view that as a separate business.
Personal Capital is completely free to use and will help you better your financial future.
Here, I will highlight a balanced approach to what makes real estate investing advantageous and disadvantageous. This will help you make a better decision about where to put your money.
Table of Contents
Should You Invest in Real Estate?
The question about whether you should invest in real estate or not is a tough one. There are a lot of variables at play here. What we know about this question is how to break down people that should invest in real estate and those that should not invest in real estate.
Here are some characteristics that might suggest that real estate investing is a good idea for you.
- Like to invest at a very micro-level (down to a neighborhood, street, etc.)
- You like simplicity
- Hustling is not a big deal to you
- You enjoy interaction
- You are willing to take control of your outcomes
Here are some characteristics that might suggest that real estate investing is not a good idea for you.
- Juggling multiple tasks at once is not your strong suit
- You want complete hands-off control of your money
- Taking a gamble or betting on yourself is scary
The above personal characteristics can be subject to certain considerations, but they are pretty accurate to what constitutes a successful real estate investor.
If you like what you heard above, how much capital should actually be committed to real estate? Let's take a second to evaluate.
How Much to Invest in Real Estate
I believe you should have at least 10-20% of your net worth invested in real estate. Much of this is dependent on your time horizon, of course. This range accounts for the ordinary investor as not many people have the stomach to account for illiquidity in excess of that amount.
Personally, I'm okay with this type of illiquidity. I have a long horizon and I love the profile of real estate.
There are a few things you need to know about real estate investing that determines the quality of the opportunity:
- Cap rate and cash yield
- Internal rate of return (IRR)
- Payback period (in number of years)
- Multiple on invested capital (MOIC)
I created a free rental property Excel spreadsheet that will help you invest in real estate smarter. Not harder.
You can download the calculator by clicking the button below. It only takes 5 seconds to download and get started.
You can invest in real estate either directly or passively.
One way to invest in real estate on a passive basis is by using a crowdfunding site like Fundrise. They are the leading platform for crowdfunding direct commercial real estate opportunities.
Pros and Cons Analysis of Real Estate Investing
Let's get into the advantages and disadvantages worth considering for real estate investing. Evaluating single real estate opportunities is much like the pros and cons of renting vs selling your home.
There's a little bit of a twist. You have to put in the work upfront. The hard work is in front of you.
Pros of Investing in Real Estate
Here are some considerations that make real estate investing disadvantageous over other types of investing.
Cash Flow & Capital Appreciation
With real estate investing, you get a crack at two things involved in the holy grail of investing. That is cash flow and capital appreciation. You can invest in properties that will immediately improve your personal cash flow, but provide ample opportunity for equity appreciation due to economic development, market dynamics, etc.
This is probably the most important advantage of real estate. There are only a handful of asset classes that can provide you both cash flow yield and true wealth appreciation.
Yes, real estate requires repairs and houses can diminish in value. But, you are investing in an asset with an indefinite life and value. Other asset classes usually run out of their project life like machinery, renewable energy, etc.
Real estate and land are forever.
I can track the cash flow and capital appreciation with ease using Personal Capital. Personal Capital automatically syncs the value of your real estate with Zillow while also tracking all bank account activity.
Once I add in my stock investments to the free net worth tracker, I can know my exact net worth on a monthly basis in under 10 minutes of work.
All for free. What would I do without it?
See Related: Should You Sell to a House Investor?
Multiple Strategy Investing
With real estate investing, you can take a multiple strategy approach. Like equity investing, you can take a variety of approaches with real estate investing.
Some of the most important real estate investing strategies include (in order of risk):
- Cash Flow Investing or Core Real Estate
- Core Plus Real Estate
- Value-Add Investing
- Opportunistic Investing
These are just a few and many people blend these varying investment strategies.
See our post on the best books on flipping houses to learn more about a differentiated strategy.
Multiple Investment Types
Let's break it down more. Secondarily, you can then take a varying strategy both by investment type of real estate, which includes:
- Single-Family Real Estate
- Duplex / Triplex Real Estate
- Commercial Real Estate (which could be broken down to manufacturing, mixed-use, hotels, etc.)
This is where a resource like Fundrise comes into play. I like to stay local for single-family real estate and duplex investing.
Then, I can use Fundrise to screen for free commercial real estate opportunities in new markets. If I find something I like, I can diversify my portfolio by investing in commercial real estate.
Mirror the fact that you can have multiple strategies within multiple investment types makes the opportunities to make money endless.
With real estate, you can make money no matter the economic cycle.
You Have Complete Control
Generally speaking, you have complete control of your outcomes with real estate investing. You are the one in charge. That can be a downside of course because you might mess up.
You have the authority to negotiate any risk into the purchase of the asset, you conduct your own due diligence (with the help of contractors and advisors, of course) and you model out the financial returns.
With index investing or other ways to invest your money, you simply don't have that luxury. You invest and you have to hope the management team makes the right decisions.
Want a separate opinion on an opportunity? DealCheck is a great app that can help you analyze and evaluate a property for potential investment returns.
Want it to be Passive? Then, Make it Passive!
Real estate can be completely passive income if you want it to be. Will it take some hard work to get there? Absolutely.
Will it be worth it? HELL YES.
Similar to the point above, you can control your outcome with passive income. You can set up the systems and hire people to manage a portfolio of assets without you seeing a single tenant or changing a single lightbulb.
Or, like the multiple strategy approach mentioned above. You can rely on others like using Fundrise to simply find commercial real estate options to start investing.
Fundrise is a free real estate crowdfunding platform that enables you to invest completely passively in either funds or eREITs. It's completely free to sign up and start browsing new opportunities.
Read more about real estate crowdfunding.
Real Estate is Simple
Investing in real estate is straightforward and easy to understand. There is a building and people need somewhere to live. People will always need somewhere to live. It's funny because people are generally concerned with market prices in the case of a recession.
Well, sometimes rents actually increase during a recession.
Beyond market driving factors, real estate is simple. You are not figuring out how Netflix is going to make money in the next 10 years like equity investing in stocks.
Or, you are not developing a new algorithm that will mine data to be sold.
Real estate investing is all about customer service and keeping quality care of your asset…
You treat your house well. Your house will treat you well.
You treat your tenants well. Your tenants will treat you well.
Sometimes, it's just as simple as that.
Location Specific Investing
Locations matter with real estate investing. A lot. What other investment can you target a specific neighborhood or even down to a specific street? Real estate opportunities are created by the people that live in the communities. This to me makes it especially appealing for investors looking to put money to work in their local areas.
There are plenty of resources that you can use to get smarter about opportunities in your own backyard (literally), including:
- Attending a city planning meeting
- Watching real estate development happening in a particular city
- Seeing news of a recent award-winning restaurant
- Visually seeing foot traffic or shopping development occur
- Knowing the neighbor and why they want to sell, which could create favorable pricing
Location-specific investing can create significant opportunities. And most importantly, above-market rate of returns.
Use a tool like Rentometer to gauge high rent areas. This can translate into higher free cash flow and additional yield to your returns.
See Related: How to Underwriter Real Estate
Cons of Investing in Real Estate
Here are some considerations that make real estate investing disadvantageous.
When you park money in real estate, you are taking a long-term view. Have an emergency? There are only a few levers that you can pull to get your equity out of your home.
Things like a Home Equity Line of Credit (HELOC) might help. Or, if you have a number of properties you likely can get a loan or line of credit based on the cash flow your properties are producing.
Both of these options are less than ideal. Plus, a home can take weeks to months to years to sell.
To counter this con, ensure you invest in high cash flow yielding properties and stash the cash. You won't have to worry about money. After you buy a property, start focusing on other ways to make money that may require a bit more hand-holding.
Requires a Learning Curve
You are not going to get every real estate investment right. Things will definitely go wrong and that's okay. It's all about positioning yourself in the best possible way to minimize downside risk/opportunity while maximizing upside.
Over time, you will get smarter about what makes up a good real estate investment. That won't happen overnight and will likely require a few bruises along the way.
You simply just need to put in the work to get better every single day.
It's a Business
By creating your own real estate investing arm, you are creating a de facto business. This is probably the single biggest prohibiting factor to people not investing in real estate to build wealth.
People think that you simply just buy a property and you make money! Yes, if you do that right you will make money.
However, there are a few things that you need to do to set yourself up for success:
- Adequate funding of reserve accounts
- Separate savings accounts to hold your tenant's money separate from your personal cash
- Potentially a separate Limited Liability Company (LLC)
- Well qualified payment system to make getting your money easy
- Properly vetting your tenants to ensure you have creditworthy tenants/rental income
There are a few more, but these would get you started to start making money as if investing was a full-time business. You can use Landlord Studio to help you manage your properties more efficiently and cost-effectively.
They offer accounting, rent collection, maintenance management and so much more.
See Related: Fundrise Review
Conclusion on Real Estate Investing
Real estate investing is not for everyone. It will continue to be an attractive asset class for entrepreneurial investors looking to diversify their cash flow while building wealth using low-cost debt and capital appreciation.
Are you going to consider real estate investing? Let me know if you have any questions.
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