What You Need to Know About Real Estate Investment
By: Jason Mountford
Tags: Investing, Real Estate, Money, Investment, Finance

It sucks

Photo by Alexander Andrews on Unsplash

The pool was green again. This was the 3rd time the rental agent had been in touch to tell me that the pool in our investment property was full of algae. The pool guys would need to get out there and do a full treatment on it, again, to get it back to normal.

I asked them what was going on. We’d spent $3,000 replacing the filter 18 months ago, had a monthly pool service set up that we paid for and had forked out for a pool cover to limit how many leaves fell in. They had a word with the tenant, and apparently the answer to this question was that he had decided that the filter was too noisy so he doesn’t run it. Bloody hell.

If you like video as well as articles, check out my YouTube Channel!

When we owned an ‘investment property’ this type of thing was a weekly occurrence in our household. The property in question was actually our old family home in Australia. When we moved to the UK the market was weak so we’d decided to rent it out. The tenants rent would pay the mortgage while we waited for the market to improve. What could be so bad about that?

The dream

There’s no other investment in the world that comes with so much free, positive press. Switch on your TV right now and I can almost guarantee that you’ll be able to find some sort of home renovation, home flipping or real estate show on. These programs promise a land of easy profits and stress free income. They would have us believe that with a coat of paint and a few shrubs in the front yard, we too could become property moguls.

From a more financial standpoint, there are no shortage of ‘experts’ who hold themselves up as examples of why you too can become the proud owner of a multi-million dollar property portfolio.

The reality

Real life is often very different. Part of the problem is the sheer amount of information and demand there is out there for people to develop and invest in property themselves. This creates a situation where even properties that need significant amounts of work, are priced based on the potential profit that a developer could make. There are also many professional builders and developers who are ready to pounce on anything that does offer good value.

This means that the absolute bargains we see on home flipping shows, are very few and far between in the real world.

But let’s say you’re not interested in renovating, you just want to buy a nice property for the steady rental income. For a start, the income and yield you are going to be quoted is gross. If the rent on a property is $2,000 a month, you are not receiving that amount in your account. There are agency fees, certain utilities, landlords insurance, repair bills and various government taxes and charges depending on where you live. Once you take all of the costs into consideration, the actual numbers start to look pretty weak.

Don’t worry, I’ve not forgotten about capital growth! According to the Case-Shiller Housing Index, the average annual return from real estate in the US between 1928 and 2013 has been 3.7%. This is compared to the S&P 500 over that same period which has grown an average of 9.5%!

From a pure returns perspective, it just doesn’t stack up. But the problems don’t stop there.

Real estate is very illiquid. For the majority of retail investors, their whole net worth is likely to only enable them to buy 1 or maybe 2 investment properties unless they use significant amounts of leverage (I’ll get to that in a minute). For this regular investor, it means almost all of their money is going to be tied up into a couple of investments that will take them, if they’re lucky, months to sell.

If they want to get their hands on $20,000 well that’s just bad luck. They can’t sell off a bedroom or a little bit of their backyard. It’s all or nothing.

This liquidity issue also makes it really hard to manage your tax position. If you do have a property that grows a lot in value, you can’t sell it off in chunks over multiple tax years to manage the tax you pay. You are going to get smashed with all of the tax in a single year when you sell it.

As well as the liquidity problems, you’ve also got tenants to deal with. And they can be a nightmare. I’m not bashing renters; I rent myself at the moment. But realistically, even the best tenants in the world are not going to treat the property the same way you treat your own home. Maintenance just won’t be as good and eventually this will mean you’ll have to put your hand in your pocket for repairs.

The single benefit that property investment has over other forms, is leverage. A bank will happily lend you money to invest in property. This means that if you have $50,000 you could use this to buy a property worth $200,000. Rather than only getting a return on your $50,000 you get to keep the return on the full $200,000. Of course, the bank will take their hefty interest payment for the privilege.

Even this isn’t a definite advantage. We all remember what happened in 2008. Many property investors had their rental properties foreclosed on during this crisis and some even lost their own homes which they had used as additional security.

The alternatives

There are so many investment alternatives that provide returns equal or better to what you can get from property, that have higher levels of liquidity and less day to day hassle. Stocks and bonds are the main contenders.

These allow you to buy and sell any amounts you like. You can manage your tax position by selling the right amount to minimise your liability and the CEO of Microsoft isn’t going to be calling you up and asking for $500 for a new kitchen tap.

I’ve talked about different types of investments in a bite more detail I this article below.

If you’re buying a property to live in as a family home, there’s almost no better investment. It provides security and stability. It allows you to change and adapt it perfectly to the needs of your family. When it comes to property purchases purely for investment purposes, I highly recommend you consider all options before diving in.

For UK readers, you can find some extra information specific to you in this video.

If you like video as well as articles, check out my YouTube Channel!