The Pros and Cons of Investing in Real Estate
Franklin D. Roosevelt once famously said that, when purchased with common sense, paid for in full, and managed with reasonable care, real estate is about the safest investment in the world. And he was spot on.
Investing in real estate can be a great investment opportunity and safe addition to your portfolio while also giving you tax benefits. However, if you rush in and make the wrong investment, it can be a royal pain and a major financial burden.
As such, it’s essential to go into the market informed about what you’re getting into. This article explores the pros and cons of real estate investing.
Common types of real estate investing
It’s important to make the right type of investment, as there are many options to consider. Let’s explore some of the more common.
Residential real estate
Residential real estate involves buying a single-family or multi-family home.
Some investors choose to keep residential real estate investments and rent them to tenants on a short-term or long-term basis (aka rental properties). Some also choose to buy residential properties, hold them for a short time, then flip them when the market is right.
Commercial real estate
You can also buy commercial property in the form of office buildings, retail shops, and larger apartment complexes.
This approach is typically much more expensive and may require working with a different type of real estate agent qualified to handle this type of transaction.
Typically, commercial real estate has been a great investment opportunity for those who buy buildings in prime locations. Yet in the wake of the pandemic, it remains to be seen whether the workforce returns to the office and whether shoppers go back to stores instead of buying things online.
Industrial real estate
Industrial real estate refers to real estate that’s used for industrial purposes.This may include production, assembly, manufacturing, or storage facilities.
Industrial real estate is also very expensive. But it typically offers long-term stability. Most companies don’t move their industrial manufacturing centers as quickly as they might transfer office space.
The easiest way to invest in commercial real estate is to purchase real estate investment trusts (REITs).
With this type of transaction, you don’t buy property directly. Instead, you purchase shares of publicly-traded companies that own and operate commercial properties. In order to maintain their REIT status, these funds are required to pay a huge portion of their income as dividends.
Pros of investing in real estate
1. Monthly cash flow
One of the top reasons to buy real estate is that it can produce a recurring positive cash flow—assuming you’re able to find renters, that is.
If you buy a rental property, you can rent it to tenants and use the money to pay down the mortgage. Once you pay the mortgage off, you’ll only have to pay for maintenance and repairs.
The trick is to find a place in a great location at a bargain price that requires minimal upkeep. For best results, look for a rental in a heavily populated place or near a lot of tourism. On the flip side, be wary of rental properties in areas that have seasonal dips or low populations.
2. Tax advantages
Owning real estate can give property owners a variety of tax advantages. In other words, there are certain expenses you can deduct from your taxable income, reducing how much you have to pay at the end of the year.
Some of the most common real estate tax deductions include depreciation credits, property taxes, mortgage interest, property management fees, and property repairs, among others. If you hold on to the property for more than a year, you may also benefit from incurring long-term capital gains taxes, which tend to be lower than regular income taxes.
Talk to a certified tax professional to learn exactly what you can and cannot deduct from your taxes when you own a piece of real estate as an investment. A professional tax representative can give you an accurate assessment and keep you out of trouble with the IRS.
The last thing you want to do is start deducting things that don’t meet the criteria for an acceptable tax deduction and attract the ire of regulators.
An investment portfolio should have a healthy balance of risk and security. Savvy investors typically allocate their investments strategically to avoid excessive risk.
Investing in real estate is a great way to diversify your asset allocation and offset potential losses from volatile stocks or funds.
4. Net worth increase
Net worth is the total sum of what you own versus what you owe. Buying real estate is a great way to increase your net worth, whether you flip a house quickly or keep it as an investment property.
Real estate is usually considered the safest investment of all asset classes for a few reasons.
First, real estate is tangible. Unlike stocks or bonds, you actually have a physical object as proof of your investment. For this reason, it’s much harder to lose. Even if the house burns down, you’ll still own the ground under it, and you’ll most likely have insurance to cover your losses.
In addition, the real estate market is much less volatile than the stock market. It’s also less subject to inflation.
Cons of real estate investing
While there are a number of benefits that come with investing in real estate, it is not without its downsides, which we’ll explore next.
Real estate investing isn’t an overnight process. It requires a lot of time and energy—especially if you decide to keep the property and rent it out. In some cases, a real estate investment can take years or even decades to pan out.
Flipping a house can take time, too. Oftentimes, investors have to hold onto properties until market conditions change or a buyer comes along.
Only invest in real estate if you have the patience to ride the process to completion. It can be quite a long haul.
2. Property management
Once you buy a property, you’re going to have to maintain it—and this can be a full-time job. It may require painting, landscaping, and regular repairs.
If you don’t want to be on call as a landlord or deal with repairs, you can always hire people to do it for you. Most real estate investors hire property managers and contractors to work on their properties. While this can be expensive, it can also make the burden much easier to bear.
3. Problem tenants
Nothing can wreck a real estate investment like a problem tenant who damages your property, stops paying rent, or won’t leave when asked.
Some states have stringent tenant rights laws, making it difficult to take action against tenants or proceed with evictions.
It’s imperative to understand the rights of a tenant in the state where you’re looking to buy real estate so you can avoid potential problems. You should also consider hiring an attorney to advise you throughout the process.
4. Changing neighborhoods
When buying real estate, you have to look beyond your property and into the surrounding area. Neighborhood quality can change over time depending on a variety of factors: like economic conditions, school system quality, crime, taxes, and weather patterns, to name just a few.
Of course, this can go two ways. Sometimes, you buy a property at a discount and then the neighborhood improves in quality, leading to an increase in value. Talk to a real estate agent and locals before purchasing to get a sense of the history of the neighborhood and where it’s likely headed over the next few decades.
This also applies if you’re planning on flipping a house. Buyers are likely to pay attention to surrounding property values and neighborhood quality, meaning these factors could influence resale value.
5. High costs
Real estate can be very expensive. You’ll have to come up with a down payment and closing costs. A down payment may cost 20% of the purchase price, while closing costs can sometimes cost 3% to 5% or more. This includes real estate agent fees, insurance, inspections, and appraisals, among other costs.
Once you own the house, you may also have to make capital improvements. For example, you may need to pull carpeting and replace the floors, add drywall, landscape, or repave the driveway.
After you make capital improvements, you’ll also have monthly maintenance costs to consider, and possibly homeowners association (HOA) fees if you buy a condo or apartment. And if you hire a property management company, this can cost hundreds or thousands of dollars per month depending on how active they are and how much property you own.
Add it all up, and real estate investment is costly and there are hidden costs you might not know about..
Before jumping into the market, it’s a good idea to talk to a financial advisor to ensure you are in the right position to do so. You certainly don’t want to get stuck with a property you can’t afford.
Tips for real estate investing
Research as much as possible
Information is worth its weight in gold when investing in real estate. Conduct a thorough investigation before buying a property so that you know precisely what you’re buying.
Start with the real estate market, and assess mortgage rates, mill rates, local vacancies, and economic trends. Consult with a trusted advisor or several and determine whether it’s a good time to buy.
You also need to conduct as much research on the property as possible. If the building has a mold or asbestos problem, you need to know. Inquire about other tenants in the building, surrounding competition, and the cost of renting elsewhere in the area.
Get the right real estate agent
Don’t just look for a real estate agent who can negotiate. Find someone deeply connected to the local area and capable of telling you things you can’t find online or on your own.
The agent you choose may make or break your real estate investment, so it’s usually worth paying top dollar for a shark.
Don’t be afraid to walk away
In business and especially real estate, the best deal is sometimes the one you walk away from. If you aren’t entirely confident about a real estate investment, you should probably walk away or hold off. Investing in real estate is a big decision, and you need to be capable of accepting responsibility for it.
One thing to consider is that it can be tough to say no if you’re working with another investor or family member. When you’re bankrolling a real estate investment, it’s your decision and yours alone.
If you’re a collaborative person, maybe it makes sense to go in on a real estate investment with a group of investors. If not, perhaps you’re best on your own.
Look for value properties
Value investing is all about identifying bargains you can get at a low price before they skyrocket in value. Keep your eyes peeled for properties selling for below market value in strategic locations.
This might be easier said than done. Still, it’s possible to snag a once-in-a-lifetime bargain.
Frequently Asked Questions
Should I rent or flip a house?
This depends on a variety of factors, including the location and condition of your property, your cash flow, and the time horizon for your investment.
If you’re looking to sell a house for a gain very quickly, flipping is the better option. If you want to make more money over time, then you should consider renting.
Take each property on a case-by-case basis and weigh your options carefully before making a decision.
Is being a landlord difficult?
Being a landlord can be enjoyable, or it can be an absolute nightmare. Again, it all depends.
It’s important to remember that tenants are wildcards. In other words: there’s no telling how someone is going to behave after signing a lease. Someone may appear to be a great potential tenant during a walkthrough and then wind up giving you a very hard time—and vice versa.
If you don’t want to deal with tenants, consider shielding yourself by working with a property management company. This company can handle all aspects of client communication and prevent you from having to get involved.
Do I need a lot of money to buy real estate?
If you don’t have enough money to cover ongoing maintenance and expenses and envision yourself pinching pennies down the line, it’s a good idea to steer clear of buying direct real estate until you have the funds to do so.
In the meantime, you may want to explore REITs. This type of investment is much more affordable, and can still potentially generate strong returns via dividends.
The Bottom Line
Whatever you decide, buying real estate isn’t something you should rush into. Do your due diligence and make sure that the place you buy can generate strong rental income or passive income.
To increase your chances of making the right decision, talk to a financial advisor and form a real estate investment strategy that aligns with your cash flow and portfolio. If you want to be a successful real estate investor, you have to plan and strategize accordingly.