In 2012, I told people I was going to invest in real estate. Most people told me it would be a bad idea. I bought my first investment, and it was one of the best/luckiest decisions I ever made. Now, real estate is back in vogue. Everyone is clamoring to get a deal because we’re back in a upward cycle.
Last December, I made an offer on a duplex that needed some TLC. The property needed about $30k worth of work, but when it was all said and done, it would make a decent return. Being I have a contractor on my team, I can now target TLC properties.
I made an offer after seeing it, and within two days, the property had about 20 offers. Some of the offers were above asking for all cash. A real estate agent told me I should have increased my asking price because the market is hot. That would be a trap.
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The Fear of Missing Out
Like it or not, we are social animals. We take our cues from the tribe to dictate what we should or shouldn’t be doing. You hear from your friend that she’s making a killing in real estate. Because you don’t want to be left behind, you feel anxious to buy a property, even if it’s a money loser.
You’re starting to feel the fear of missing out (FOMO). This is a feeling I know well because I’ve acted on it before (and it cost me $25k). You forget that all great investments require knowledge, experience, and hustle to locate. Instead, emotion clouds your judgment. Your criteria takes the backseat. Investing turns to gambling.
Gambling comes in all different shapes and sizes
I see people gamble by buying in areas they are unfamiliar with so they can chase returns. I see people buying overvalued properties that aren’t breaking even. But the worst thing I’m seeing is people justifying buying money-losing properties for tax benefits.
Why Investing for a Tax Break Is a Bad Idea
Call me old fashioned, but I prefer all my investments to carry their own water, regardless of whether I’m working or not. I invest to work less, not work more.
The logic holds that instead of paying Uncle Sam taxes, one should buy a money-losing property and use the losses to offset your taxable wage income. On face value, it seems reasonable.
But there are a few assumptions being made:
- Your job is safe
- You will remain in a top tax bracket
- Other investors value the property the same way you do.
Your job isn’t safe.
With the shortening life span of companies and a changing economy, job security is not what used to be in America. With the onset of automation, which is a blessing for some and a potential disruption for others, it’s not guaranteed that your company will maintain its current headcount, that your role will be relevant 5-10 years from now, or that the division you work in will be relevant to the company in the near future.
You won’t remain in your current tax bracket.
While I want everyone here to become wealthy, odds are we will face financial setbacks in our lives. You might be in the top tax bracket now because the job market is good, but how stable is that job you have? How long do you think you’ll be able to maintain your current earnings?
Those of us working in the tech sector face the same job risks as those in the service economy. All it takes is for you to lose your job, and now you have a money-eating property on your hands. This can cause panic selling (see the 2009 financial crisis). But this isn’t just a bad idea for yourself; think of your family.
Let’s assume the worst—tomorrow you are crushed to death by Pikachu or this cat. What would happen to your significant other if they have to worry about a money-draining property?
You property valuation model is flawed.
The method you are using to value the property is flawed because it assumes the rest of the market is looking at the property the same way you are. While future buyers are basing the property’s value on future comps or cash flow, you are basing it on your personal financial situation. The mismatch of perception of value will cause you to overvalue a property. And if the market turns, you’ll might be forced to sell the property for a significant loss.
It’s Time to Put the Gambling Chips Down
Buying money losers for a tax break isn’t investing; anyone can do that. That’s considered shopping. Investing is the act of deploying capital for a expected financial return, not a tax shelter for W2 earnings.
As you well know by now, yours truly is conservative when he invests. While others are willing to pump themselves with investing steroids to crush a home run, yours truly is like Cal Ripkin, fine with a hit here and there. So long has he can coast into Cooperstown (retirement) in one piece without risking losing money in real estate, bankruptcy, or steroid-induced man-boobs.
Wealth building is not about who builds their nest egg the fastest. It’s about who is able to survive the ups and downs of the market while others are losing their minds. That’s where the experience is gained. That’s where you learn to spot good deals. And that’s where the wealth lies.
[Editor’s Note: We are republishing this article to help out our newer readers.]
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