3 reasons why real estate investing is misunderstood
I’m the first to acknowledge that LOTS of people have made fortunes investing in private real estate. And nobody complains when the cash flow from rent checks pays for their own home mortgage and vacations.
And I get it. Real estate seems a lot easier to wrap your head around than the stock market. You can touch and feel a hard asset (the home or building), and when you say, “I bought this,” you have something to point to.
Collecting a monthly or quarterly rent makes a lot more sense than receiving a quarterly dividend check from a stock you own.
But real estate, as an asset class, is misunderstood. People I talk to think, “I’m going to buy some multi-families and live off the rental income. Easy as that.”
True, that can happen, but here are three overlooked points when considering real estate as an investment.
Borrowing money is a gamechanger.
It's normal when considering a real estate purchase but taboo in an investment account.
When you buy an investment property you put as little cash down as possible so you can borrow, or leverage, the rest from the bank. For a large investment property, it’s typical to borrow 75% from the bank and pay it back over the course of 15-30 years.
But could you imagine leveraging the stocks you own and borrowing money to invest in more stocks? It sounds crazy, right? But it’s entirely possible. And usually money is borrowed at a 2:1 ratio in investment accounts, meaning if you have $100,000 invested, you can borrow another $100,000 and invest a total of $200,000.
Let's look at an example: say you buy a million dollar property and put $250k down. If the real estate market crashes and drops 25%, you've lost all your money.
If you invest that same $250k in the stock market and borrow another $250k (2:1 ratio) and the stock market drops 25%, you are down 50%. The knee jerk response is, "I'll just hold the multifamily until the market comes back." And assuming you can continue to make mortgage payments, that's a good idea.
That same knee jerk response is exactly how you should think about your stock portfolio when the market declines.
And believe it or not, I've run projections comparing leveraged investment accounts and multi-families over 30 years, using historical national averages, and you wind up with more money in an investment account without the headache of being a landlord.
Businesses don’t want a mortgage on their balance sheet.
If you had the choice of owning a building or all of the businesses inside the building, which would you choose? History says if you are trying to make the most money possible you should own the businesses, not the building.
The overwhelming majority of businesses opt not to buy the building they are in because the expense will eat into their profit margins. Instead, they are happy to lease the space in exchange for more free cash to grow their business.
Consider Amazon’s recent purchase of Whole Foods. Many analysts talked about the real estate play Amazon was making when purchasing Whole Foods, but they weren’t saying that Amazon is more valuable because it owns hard assets necessarily.
The analysts were excited to see Amazon’s instant access and distribution centers in key locations around the country so that it could continue growing its core business. The business growth was the driver, not buying buildings with Whole Foods signs. The hard assets are the cherries on top in this example.
You better be an expert.
I’m interested in real estate, so I follow some very successful real estate investors. And a guy like Grant Cardone, for example, who owns nearly a billion dollars worth of private real estate assets, says he will look at hundreds if not thousands of different properties around the country for multiple years before buying ONE.
Your nightly Zillow search probably isn’t going to cut it.
Making money in real estate isn’t about finding a price cut on Redfin and buying the property. You need to be in the neighborhood for months, watch traffic flow, pay attention to renter demographics, construction in the area, housing market trends, average occupancy rates, tenant turnover, corporations moving in or out of town, school systems, etc.
You can get lucky, sure, but the real money is made through good old fashioned hard work and preparation. And if you aren’t willing to put in the time and effort, then you better hope you get lucky.
But hope is not a strategy.
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