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Monday
Aug092010

The Real Estate Debate! 

Back on track!! I am so excited to be back on schedule. I hope that you all are too! We are kicking Monday off with a little real estate debate. Make sure you leave your comments below and enjoy!

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A few people close to me professionally and personally are absolutely set in their ways about their real estate. They believe that the only investments they need are the properties they acquire and that those properties will provide the income they will need for the rest of their lives. They even went as far as claiming that investing in real estate yields a higher return and is safer than any other investment portfolio you could possibly construct.

That’s when I lost it.

Don’t get me wrong I can absolutely see the value and allure that real estate has over people. Thinking that buying land, amassing rental properties and flipping houses is the only way to make your money work for you is a little bit of a stretch. So in all fairness I tried to map out a few of the pros and cons to owning real estate, as an investment choice, just so I could see from where my colleague’s intensity stem.

Just like any investment decision you should objectively take a look at both sides and make sure that you are comfortable with the risk and the behavior of the financial vehicle. On to the list!

Pros

  • Tangible – Real estate is a physical asset. Unlike equities at the end of the day you still own the properties even if their perceived value at a specific time has deteriorated.
  • Income producing – Rental properties have the potential to produce steady income streams for extended amounts of time. At times if a rental property is financed the income it throws off can be used to cover the costs of purchasing it. If owned outright, the investor owns the property that is hopefully appreciating along with collecting rents (less the costs of maintaining the property).
  • Markets aren’t “efficient” – In real estate there tends to be more “wiggle” room for price negotiation in the buying and selling process. There is more of an emphasis on perceived value and quantifying that perception from individual situation to situation. This can allow for very high yields on investment. That potential for unconventional gains is what draws people into real estate.

Cons

  • Liquidity – Piggy backing off of that last pro point, if you’re in the business of flipping houses cash can be tied up for extended periods of time. In the event you don’t find a price that the market accepts you could be sitting on your investment for longer than you expect causing financial chaffing. In some cases with equities it’s as easy as a click of the mouse moving from investment to cash and vice versa.
  • Diversification – Real estate is just like any other financial market in that it has its own ebbs and flows. At the moment we are currently on the tail end/start of a recovery in the US housing market. If all you invest in is real estate though your principal is 100% at the mercy of the state of the overall real estate market. If owning a portfolio of physical properties is you preference your biggest hedges against market volatility would be your income producing properties. (For the sake of this argument we are not taking into consideration any securitized form of real estate investing like REIT’s or investment of the underlying commodities that support housing markets like timber.)
  • Liability – Owning stock in a firm does not directly expose you to the debts or liabilities of that firm. With property the owner assumes all the liabilities that go along with owning the property. In the event of an accident or negligence the owner can be held liable to satisfy damages incurred in the event of being served (sued). Another form of liability can come in the shape of unoccupied rental units. If no one is living in your three-family house that doesn’t mean you can slouch on the mortgage payments. Owners are still responsible to pay for and maintain their property which could potentially mean more cash out flows than prepared for.

I strongly believe that real estate is an absolutely appropriate piece of anyone portfolio. I also believe that flipping houses and owning rental properties could be an amazing way to supplement an income (or be your income entirely). I don’t believe it should be the only thing you bank your financial future on. Diversification creates protection or at least softens the blows when markets are ebbing and flowing. At the very least I hope that I provided some objective information to both sides and that my colleagues at least see where I’m coming from :).

What do you think? Do you think that there is any merit to diversifying if the only business you’re in is real estate? Are there any pros or cons that I missed that are worth mentioning in this little debate?


 

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Reader Comments (4)

I've considered buying a rental property in the past, but it seems like it would be a pain in the ass to manage.

One very, very big advantage with real estate property is the easy 5:1 leverage you get with the bank (try taking out a 250k mortgage for a portfolio of ETFs!), and the same easy leverage if you want to pull equity back out and buy a rental property with it! This leverage can be very powerful in building wealth, especially with cashflow positive rental properties.

August 11, 2010 | Unregistered CommenterKevin@InvestItWisely

Diversifying is DEFINITELY a must as the real estate collapse has shown. However, pretty much everything has gone DOWN in value except for bonds and cash............

I love real estate, b/c it is a tangible asset. Money is nothing except for the things we can buy with it.

In the long run, we should own something, and not money.

Best,

Sam

August 21, 2010 | Unregistered CommenterFinancial Samurai

The Real Estate topic must be discussed on both the two aspects. Every thing has some pros and cons.I think there is no solution of this debate.It will be continued.

CEA Approved RES Course Provider

I believe on this part "owning rental properties could be an amazing way to supplement an income." It also called rent to own and I will suggest it to all people who are planning to invest new properties.

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