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Is Real Estate a Good Investment? (Nope, However…)

by Brandon Turner on May 13, 2014 · 26 comments

  
Is Real Estate a Good Investment?

Is real estate really a good investment?

I mean, sure it’s tangible. Yes, it’s cool. Yes, it has worked for some, and it’s done wonders for me.

In fact, this entire website is dedicated to real estate investing and perfecting the art/science/luck of it. Hundreds of books have been written on the topic (including these, my top 21 favorite real estate books.) Each week on the BiggerPockets Podcast tens of thousands of listeners tune in to hear the best tips, tricks, and strategies for building wealth through real estate.

However, it’s rarely discussed – is real estate, itself, a good investment? And if so… why?

Is Real Estate a Good Investment? Nope!

Historically, real estate actually has NOT been a great investment in itself. I know, a lot of you just choked on your lunch hearing that come from me, but bear with me a moment.

As famed economist and Nobel prize winner Robert Shiller has pointed out using the S&P/Case-Shiller Index, home values have actually appreciated, on average, at nearly the same rate as inflation over the past 100 years.

In other words – if you paid $100,000 cash for a home in 1970 and sold it in 2000 for $250,000 it may seem like you made a terrific investment. However, that change is only maintaining a 3% annual appreciation, pretty similar to inflation. They home hasn’t actually built them any wealth.

In addition, the home needed new windows, carpet, paint, and other changes throughout those 30 years, so it’s very possible that the owner of that home actually LOST money on their home purchase.

So, yes – buying a home with your $100,000 is probably better than tossing it into a bank account earning no interest but in itself, it’s really not a great investment. You’d probably be better off sticking that $100,000 in the stock market and earning an average of 8%.

However…

As most real estate investors are screaming at their computer screens right now – there is a lot more to the picture that economists and financial advisors conveniently forget. Especially leverage. You see, most individuals don’t pay 100% for their home. They use a mortgage and take advantage of the wonderful world of using other people’s money (OPM). Although the person may have only put down 20%, they are able to realize the appreciation benefits of the entire 100% and cash flow whatever isn’t spent on the low interest mortgage payment.

For a more in-depth and intelligent discussion on the concept of leverage and misconceptions among economists, see Leon Yang’s Debunking the Buying a House is a Bad Idea Myth here on BiggerPockets.

You see, while homes may only be appreciating at 3% per year on average, if a person applies a loan to the equation the math changes quickly, for the better.

Is Real Estate Really an Investment at All?

Okay, so real estate, in itself, is not a great investment vehicle. So… why do we talk about real estate investors so much?

The truth is … most of what we do here on BiggerPockets is more akin to “real estate entrepreneurship” than “real estate investing.”  We are business owners who use our brains (some more than others) to make income bleed from a normally bad investment – real estate. Yes, in the strictest sense of the word, we are usually “investing” because we are putting money into a project and hope to earn a return. However, we are also usually putting some kind of direct control or effort into the investment which makes it more of a business.

So… which is it? Is real estate an investment or a business?

Yes.

I believe the definition of investment is more like a sliding scale rather than an on-off switch. I believe every investment has a level of passivity – even mutual funds (you still need to pick them, or meet with an advisor to help you.)  Therefore, rather than thinking of it terms of “is this an investment or a business” I prefer to think of it on the “Sliding Scale of Passivity” as seen below:

RealEstateGoodInvestment2

Any investment could be anywhere on this line. For example, house flipping would probably tend to fall much closer to the “business” side of the line than the investment side. On the other hand, NNN Lease Investing would probably fall on the far left.  There are hundreds of ways to invest in real estate, and the level of passivity would cover every pixel of the sliding scale above. Furthermore, different niches and different strategies can be done in more or less passive ways. For example, I know house flippers who flip hundreds of homes each year without ever stepping into the property. Others, however, flip one or two homes each year and do 90% of the labor themselves.

Is Real Estate a Good Investment… For You?

So, we’ve decided (or, at least, I have) that real estate, in itself, is not a great investment.

Of course not, but could one be better or worse for you?

Definitely.

If you are struggling to find out what niche and strategy is best for you, I’d recommend reading through The Ultimate Beginner’s Guide to Real Estate Investing here on BiggerPockets. It will give you a great overview of the different ways you can make money as a real estate investor and allow you to see the “big picture” of the real estate investing world.

The point I’m trying to make is this: Stating that, “real estate is a bad investment” or “real estate is a great investment” is useless. We have to dig in deeper. Context is everything.  So next time an economist starts to tell you (because I know you have a lot of conversations with economists…) “real estate is a terrible investment” you know to dig in deeper and start asking questions. It’s not every day you get to be smarter than an economist – so take a moment to shine.

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{ 26 comments… read them below or add one }

Mark Ross May 13, 2014 at 8:43 am

Wow. I just can’t believe you just said that.

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Brandon Turner May 13, 2014 at 9:36 am

Hahaha Mark. I’m still a fan of RE… but it’s the strategy that matters, not the asset itself!

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Robert May 13, 2014 at 9:39 am

It seems in your first section you use “Real Estate” as a general term instead of “Your Personal Home” which seems to be what you’re specifically talking about. I don’t know if you did that to start the wailing and gnashing of teeth or not. :)

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Brandon Turner May 13, 2014 at 10:45 am

Yeah, I decided to focus a little on the idea of a home later in the post, (and I was too lazy to dig into the idea of other real estate niches and their appreciation historical rates!) BUt yeah… I like some wailing and gnashing of teeth!

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Jeff Brown May 13, 2014 at 10:42 am

A median priced San Diego home was around $18k in 1970. Let’s round up to $20k. In 2000 that home might’ve been worth around $250k. That’s just over 8.75%. ‘Course, leverage is the big difference maker when intelligently applied. What remains true now, and has been true for generations in America, is that the common denominator to wealth has been real estate investment.

Works for me.

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Brandon Turner May 13, 2014 at 10:48 am

8.75% is definitely better than inflation has been, but that’s only if this property was cash-flow even of course. Combine positive cash flow it would probably be better, and yeah – add some leverage in there… it should be much better.

But Jeff… you aren’t advocating buying in California now, are you? :) I know you better than that!

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Jeff Brown May 13, 2014 at 10:52 am

The cash flow on a free ‘n clear SD home for 30 years woulda pushed the return to double digits, imho, Brandon. And for the record, you’re right, I strongly recommend against any real estate investing anywhere on the west coast. :)

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Kevin Yeats May 15, 2014 at 3:01 pm

I’d still take that $20,000 and meet with two guys named Steve ….. (Jobs and Wozniak).

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Kevin Yeats May 15, 2014 at 3:31 pm

Of course Apple was not in business and not a publicly traded company in 1970 but in 1980 Warren Buffett’s Berkshire Hathaway was trading at $275 per share (sorry, my Yahoo stock market data does not go back further). $20,000 buys about 72 shares which today would be worth nearly $14 million …. all capital gains as Berkshire does not pay dividends.

If a Berkshire investor needed some cash, a simple phone call to a broker or today a few mouse clicks and the investor has sold the stock and the funds hit his/her bank account in a matter of days … or in some cases minutes.

Yes … this is all looking with perfect information as I know the results.

The question, in regards to ANY investment – stocks, real estate, bonds, commodities or lottery tickets, is which asset (investment) will increase in value TOMORROW. And that is a question to which no one KNOWS the answer.

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Paul May 13, 2014 at 12:24 pm

Hi Jeff-I have a question for you. If you were to pick the 3 best out of state markets to buy rentals where would you go and why. Reason I ask is I have a SFR I purchased almost 3 years ago for 65K and it is now worth 225K and a duplex 2 years ago for 104K that is now worth 225K. SFR rents for $1150 and duplex rents are $1950. SFR is in Menifee and the duplex is in Hemet, both in Riverside County. I’m thinking of selling (or exchanging them) for out of state property next spring when values top out (in my humble opinion). I’m looking for cash flow, stability with appreciation potential and landlord friendly states (aren’t we all). Your opinion is highly valued!!! Thanks!!

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Jeff Brown May 13, 2014 at 12:46 pm

Hey Paul — I know many investors who kicked major butt in Riverside county after the bubble went splat. My problem isn’t the rent/price ratio, though for most of CA that IS the problem. It’s that the location of most of the Riverside inventory that’s affordable is generally in neighborhoods attracting tenants I don’t want. That doesn’t mean you haven’t done exceptionally well with yours. But I know that area, having had multiple family living there since the 1950s.

I’d rethink your timing. I have no idea what the interest rate will be next year, or what may or may not happen to the SoCal market by then. Remember, employers are leaving your area in droves. So are the best ‘n brightest of its citizens. If it’s logistically possible I’d move now.

I’m biased towards the general Texas market, Paul. With some exceptions (Boise) I put my clients into various TX markets. So far, the Dallas/Fort Worth MetroPlex, San Antonio/New Braunfels/ and general Austin areas are my favorites. Rents have been rising steadily, as have values, but I wouldn’t ever advise you to invest there with ANY expectation of rising NOI or value appreciation.

Investors tend to vote with their capital, right? Even in the worst of times most of the new property projects I’ve recommended have sold out 50-100% before completed. In the last couple years that’s been true at 100% sold, without exception. Think of the TX economy as the polar opposite of CA. :)

The courts don’t favor anyone. They favor the contract, viewing it as the most important factor. This results in tenants losing way more than they win, as judges generally look at the contract, then the tenant’s actions, then pound the gavel. Unlike CA, an eviction in TX goes fairly quickly and more smoothly by far.

As far as cash flow goes, like you, I’m for it. :) The difference though in my outlook compared to many is that my looooong term outlook insists on very high quality locations. We both know the higher quality location usually offers a somewhat lower cash on cash. However, over time, the investor/landlord ends up understanding why their initial investments elsewhere, in inferior locations did not measure up in the long haul. Make sense?

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Paul May 13, 2014 at 12:55 pm

Thanks Jeff everything you pointed out makes sense to me. I may have to really consider doing this sooner rather than later. Texas was an area I was really considering for those reasons but just did not know where to start. You may have a new client. Go Texas!

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Jeff Brown May 13, 2014 at 1:09 pm

Contact me any time, Paul. Just tell me you’re ‘Paul from BP’. :)

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Paul May 13, 2014 at 1:17 pm

Will do-Thanks!

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James Pratt May 13, 2014 at 1:07 pm

Brandon, I look at it this way: 20% down is all one has in the property. At 3% growth in 18 years your 20% grew to 100% thanks to the renters, not to mention tax write offs and positive cash flow every year.

If you divide $100,000 by 27.5 you get $3,363 in tax write offs, that’s a lot more than the $20,000 it cost you to buy. I’m not a CPA but this works for me!

By using leverage, my renters have bought me a lot of nice homes for very little out of pocket money, mostly their money- my labor.

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Brandon Turner May 13, 2014 at 8:27 pm

Very smart James, exactly my thinking. This is something the economists don’t talk about – all they look at is appreciation. Again, it’s not the asset class you invest in… it’s what you do with it! And there is so much more you can do with RE than most other things!

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Kyle Hipp May 13, 2014 at 9:09 pm

Robert Shiller was not talking about real estate In general as an investment but rather a primary residence as an investment. There is no cash flow when you live in the house. He broke it down into a cash purchase just as an investor would to compare apples to apples. I believe in the Q & A section on that piece he alluded to the “tremendous value” in owning rental properties.

This paper has been discussed a lot recentlt and it is interesting to see all the different takaways.

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Roy N. May 14, 2014 at 9:02 am

Brandon,

Further support of why you need to approach real estate as a business, not a place to plant your money in the hope that it grows.

Cash-flow, supported by leverage, is the bases of this business, but you need to innovate and bring additional value (energy efficiency, complementary services, collaboration with other neighbourhood businesses) to stand above the competitive offerings and increase your margins.

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Evan May 15, 2014 at 9:47 am

Real estate=YES
Market=NO
Put your money in the market what have you got toilet paper or buy real estate and you have something you can touch!
Retired Real estate investor making 20+%.
Real estate Did it in the 70′s then got a real job. Lost my net worth twice in the market listening to “PROFESSIONALS”. Started messing around owning rental properties after the crash 4 years ago. 20+%Income+depreciation+appreciation+cash flow.
Buy real estate work for yourself don’t listen to professionals!

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Wilson May 15, 2014 at 10:27 am

Capital gains is only one of two components from which ROI is calculated. Let’s not forget the dividend (rent) component.

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Brandon Turner May 15, 2014 at 10:36 am

Hey Wilson,

I agree – but that falls into the “What you do with it” category, right? Real estate, just sitting there alone, is a pretty crappy investment. However, when you do something with it (rent it, flip it, leverage it, etc) then it becomes much more powerful!

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Michael May 15, 2014 at 11:53 am

I may have missed it but buying distressed, fixing and holding also increases your gains drastically over the long run.

But, I agree, there is much more to REI than just the base appreciation.

When you factor in principle pay down from rent, cash flow every month, added value when buying and appreciation it changes the picture quit a bit.

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Britt May 15, 2014 at 11:56 am

I’ve never been able to live in my IRA or personally add value to a stock certificate.

If you purchased a home for $100,000 w/ 20% down at an interest rate of 5%, amortized over 20 years and it increased at a rate of 3% per year, you would have paid out $146,711.50 over 20 years for an asset that is now worth $180,000.

Had you put the same $20,000 into the stock market earning 8% interest and made the same $527.96 monthly contribution to your stock portfolio (mirroring your PI payment w/ home ownership), you would now have a portfolio of $409,515. Assuming an average rent of $1000/month over that period you’d net $169,515.

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Deanna May 15, 2014 at 4:27 pm

As above posters have mentioned, it’s not just the purchase/sales price, but what did you do with the property in the intervening 44 years.
As an example of the extremes;
In 1969 a friend of mine purchased a house in San Francisco for $17,500. He chose it carefully for location, quality of construction, etc. It just sold for $850k. I know, “San Francisco is an extreme example! California is DIFFERENT!” (all true, BTW).
However. He purchased in San Francisco, but lived elsewhere. It was a rental for 15+ years, & the renters “bought the house” for him. He retired, moved into the house, & lived in it for the next 20+ years. Housing in SF for 20+ years, & at least $850k profit, even after expenses. Not bad
Same person inherited his parents house the central valley, kept it for 30 years empty, so even though he got it for “free”, he has “lost” money paying for the taxes, maintenance, etc.

Same person, same time frame,both “investments” in Real Estate, different results based on use of property

(BTW, the keeping inherited house vacant for decades is not as uncommon as one would think — anyone out there who can come up with a workable solution to converting probate and inherited family property into rentals could have an amazing business).

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David Trounce May 15, 2014 at 4:35 pm

I think that the distinction between those who are flipping, investing, etc real estate for profit and those who are trying to sell their home for more than what they paid (i.e, a home owner), is an important distinction.

One carries a sentimental weight and a basic living need to be met, the other involves an entire business model. On the whole, I would rather invest in a house with the single goal of making a profit than be a home owner who can’t sell their house for what they paid.

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Matt Maurice May 15, 2014 at 9:11 pm

This article does a fantastic job of putting into words what I have thought for years.

I always cringe a little when friends or people I meet “invest” in real estate by purchasing a home. Almost always they refer to throwing their money away on rent. When I begin to argue the opposite (naturally after already explaining my profession as a full time real estate investor) the face of confusion begins. Particularly first time home buyers don’t understand the true costs of owning, maintaining and repairing a home. If it weren’t for being in a home I am now emotionally attached to, I would sell and rent; the maintenance/repair savings, lawn mower, snow blower, landscape tools that I would sell would quickly turn into another cash flow property.

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