Today I had a very interesting discussion with my father. He was telling me about the opportunity in the real estate market with the depressed prices and the low interest rates. I listened and partially agreed. I respect his opinion, but I look at everything objectively as well.
With every opportunity comes a sacrifice. So,let's weigh the opportunities in the real estate market against the sacrifices...
Opportunity: Buying at a low price. Everyone knows you buy low, then either wait for the value to go up with the rest of the market or invest in rehab labor and materials to support a higher asking price and then sell high! So, if your goal is buy low, sell high, this is the perfect time to buy right? It depends, lets take a closer look at 'sell high'.
Sacrifice: Accepting the risk that the price is low for reasons other than the general "buyer's market" The price may be low for a number of reasons: property was poorly maintained, bad LOCATION, LOCATION, LOCATION, or legal/tax lien issues with the property. Make sure that your agent or you yourself (this is wealth guru U, right) thoroughly investigate these potential issues. Also, consider the fact that we have record oversupply in real estate and many people are concerned about their job security/lack the premium credit to buy in these tighter credit markets. So, your pool of potential buyers is significantly lower in the current economic state and may be for a while (the real estate market historically moves fairly slow.)
Opportunity: Collecting rental income You could profit several hundred dollars a month or more depending on the difference between your expenses (mortgage, maintenance, property management) and your rental income and tax advantages. But what kind of cap rate or rate of return can you expect? Depends, maybe 4-7%.
Sacrifice: Accepting the risk of losing money In this buyer's market can you really expect to charge a decent rent premium? Maybe.There are some exceptions. I hear about renting to section 8 tenants and the government paying rent that is sometimes 2-3 times higher than the mortgage, but you get a higher return because you take on a higher risk. Section 8 tenants have kids, sometimes many and they themselves may spend more time in the house so with higher occupancy, naturally comes more wear and tear and more maintenance calls (more time, more $). If your target is the average person, then the rent is not as guaranteed and you will also have periods of vacancy.
Opportunity: Equity! Owning an actual building/house! I mean it does sound fancy to say, "I work for ComEd, but I also own properties." "Wow, he/she must be really building up a nice net worth right?" People often say, "Why pay rent to someone else and make them rich, when you can own property!?" I agree it is better to build equity if you get a good deal on your primary residence, but what if you are simply buying real estate as an investment to build your net worth?
Sacrifice: The bank has rights to the property until you pay that loan off and you could sell it, but real estate is not exactly the most liquid asset. You may have noticed that I brought up the subject of net worth. Net of what? Your debt! A sensible mortgage is not seen as 'bad debt' compared to a high credit card balance, but the fact remains that it is still debt. Don't start feeling fancy until you pay off a mortgage or two. Don't believe me? Ask a couple real estate developers who were over-leveraged prior to the economic downturn and were unable to make payments on vacant properties. The banks came and got their rightful property, the building/house, or in bank terms - the asset that secured their loan.
But, you say "Even if a property is not paid off, I could still sell it. So, it is mine to some extent." You are right, but it is a little more complicated to sell a house, a lot of obvious factors come into play which make real estate a fairly illiquid asset, especially in a time of economic recovery like today.
Recommendation: Consider all of significant factors:
-Potential for appreciation of the property
-Time horizon (how long until it significantly appreciates)
-The location of the property, the condition, tax/legal issues
-Potential net profit from rental cash flows
-Vacancy/risk of not collecting rent, or collecting less rent than covers your expenses
-Expenses such as the mortgage(debt), maintenance and property management on top or the mortgage
-Tax deductions, building equity
- A potential drop in real estate values
-The liquidity of real estate or lack there-of in these credit markets (how long do you think it will take to sell if you had to relocate or wanted your money?
-How do you think you would handle being a landlord? Could you evict someone? Do you want to spend time managing the property or managing your property manager?
And my favorite thing to consider, could your investment of the down payment and monthly payments get a better return in real estate stocks (REITs), mutual funds, a well-researched and regularly monitored portfolio of securities (ask me about Horizon Investment Service), an investment in a 'best-fit' business based your market(people you can sell to) and passion?
I personally am a believer that outside of my primary residence, I don't need any more mortgage debt or illiquid assets. I am confident in the investment service that I use (and regularly audit its recommendations) and my own research and analysis and individual stock picks (my mutual funds are guided by Compass Investors' Horizon Service and I have an individual brokerage account).
I believe I can achieve a better return from securities (compared to owning real estate) and enjoy the comfort of being able to sell in minutes and get the cash in hours (high liquidity).
This decision is respective to my comfort level and confidence in my abilities to achieve success using other options. Make the decision for yourself, after all, this is Wealth Guru U!
I can objectively offer guidance though. Feel free to ask me further questions...