I buy real estate.
I actually buy quite a bit of real estate. Should you?
I’m not telling you to rent for the rest of your life; owning your home has its advantages. However, before you start investing in real estate, sanity check yourself. Below are four statements—if you find yourself agreeing with any of them, alarm bells should be going off in your head.
1.) You’ve Listened to a Guru in the Last Three Months
Real estate gurus are full of it. They are paid to sell. The more they can get you excited about making an investment using their “system,” the more money they make. How do they get you amped up? By making every aspect of investing sound easy and lucrative. In other words, by convincing you that you live in an imaginary world where any novice can make millions overnight.
It’s never that easy. Investing in real estate is a job. Expect years of hard work and learning before you start making much headway.
How do you know if you should tread lightly? Well, ask yourself the following: Do you feel excited about investing in real estate and want to get started as soon as possible? Are you putting together a plan for when you’ll retire? Do you have visions of yachts and Ferraris in your near future?
If you answered yes to these questions, stop. Don’t rush into things—take time to learn the business, and temper your expectations.
2.) You Don’t Have Much Money
Don’t buy a property with little or no money down. Sure, you could “win” and make some money. You could also win on the slot machines at the casino.
Let’s take an example: You buy a $100,000 house with no money down and it could yield $100 per month in cash flow.
There aren’t many ways this situation can get better. Rent rates plod along; it’s rare you see a large increase in any given year. However, once you find yourself relying on future price increases to justify an investment, you cease being an investor and become a speculator.
You know who else is a speculator? Yep, Grandma on the slot machine.
Catastrophic risks are huge: The local economy changes. The state goes bankrupt. The mafia makes you an offer you can’t refuse. The point is, there are innumerable things outside of your control that could happen to your property.
So… limited upside and significant downside risk? Doesn’t sound like a great model, does it?
Sure, people have made money using this approach, but how many? Was it a result of luck? Probably. If you want to read more about this, check out the book Fooled by Randomness by Nassim Nicholas Taleb.
3.) You Want to Leverage the Money You Do Have
I’ve heard the argument that real estate is a great way to get leverage. For a small up-front cost, you can own a lot of real estate.
This is crap. Real estate is one of the worst ways to get leverage.
Some reasons why:
- The transaction costs are higher. Loan origination fees on a stock margin account? I think not.
- Interest rates on real estate loans are much higher. Last time I checked, 30 year mortgage rates are 4.1%. The highest rate on Interactive Brokers is 1.58%.
- You can get more leverage in other ways. Take a glance at derivatives. Trading futures and options can garner you over 100:1 leverage. You should never do this, but if you really want to “get rich or die trying,” that’s the way to do it.
4.) You Have a Full-Time Job
This is controversial, but it comes down to time commitment.
A guideline I like to use for first-time investors is the rule of 10s. For every 1 home you buy (20 hour commitment), you’ll make an offer on 10 (5 hours each); for every 10 offers you look at, you’ll visit 100 (1 hour each); and for every 100, you’ll check out 1000 online (10 minutes each).
In total that is 336 hours for your first property, or about two months of full time work at 40 hours per week.
Be brutally honest with yourself. Do you have that kind of time?
Wrap It Up: Why You Shouldn’t Buy Real Estate
Real estate makes sense when you’re big. Thanks to economies of scale, everything starts to get cheaper: labor, materials, property management, closing costs, lawyer costs, accountant costs, etc. Plus, you can afford to delegate many of your lower-value tasks.
What can you do in the interim? If you’re passionate about real estate and view it as a hobby, by all means get cracking.
If you’re only interested in real estate as a way of making money, then you have two options:
- Learn everything you can whilst saving up, so that when you enter the market you can start with economies of scale.
- Find someone who has economies of scale and invest along with them. Notice I said along with them—make sure they have skin in the game and a strong track record.
What do you think?
Photo: gak4 Reasons Why You Shouldn't Buy Real Estate (Yes, I'm Serious!) by Kenny Estes