Carefully consider how real estate can be part of your portfolio
Home is where the heart is. It’s also where a lot of your money is if you’re a homeowner. For most people, real estate is the biggest investment they’ll ever make in their lifetime—and it is property that has provided a pathway to wealth for many Americans across generations.
But even though homeownership offers great potential, there’s a lot to consider before making the investment—and it might not be the right investment for everyone. Real estate agents and financial experts agree that investing in a home, whether it’s your primary residence or a rental property, is a move that should be done with great care and professional guidance.
Why Real Estate Might Be Right for You
For those who are a good fit, real estate really might be the best investment they can make. “There is a limited and finite supply of real estate,” says Ann Alsina of CovingtonAlsina. “In the long run, residential real estate grows at about 5 percent annually. That’s the growth of the asset itself.” For people who are buying rental properties, she points out it can be even more lucrative. “Then you add in cash flow from rent, and it can be a strong investment.”
The other strong sell about real estate is that its worth can never drop to zero, which is different from other investments. “Real estate will always have residual value,” says Brad Kappel with Sotheby’s International Realty. “And it is something tangible you can use and enjoy, unlike a typical investment you just look at on a spreadsheet.”
But maybe the best reasons tangible real estate is a great investment are because it’s not something easily bought and sold or traded (outside of REITs, which is another subject). “In my opinion, the number one reason real estate is such a good investment has nothing to do with real estate,” says David Orso with Compass Real Estate. “It has to do with discipline. Real estate is a tough investment to trade and an expensive investment to trade. Therefore, the investor of real estate is typically forced into a hold position and most investments, real estate included, reward a patient strategy and reward holding the investment; not impulsive, reactionary trading.”
Should You Buy Property to Rent Out?
If you’re somebody who is looking at real estate as an investment, it’s important to distinguish which approach you’re taking: Are you buying a house as your primary residence that will build equity or are you buying a property you’ll rent out to bring you extra income. Although both types of ownership are investments, it’s typically the latter that people refer to as investment properties.
“An investment property by definition should be a real estate investment other than your primary home, which generates cash flow,” Orso says. “Generally speaking, investment real estate is an illiquid asset so it can be cash intense. My advice for new investors is to make sure you have at least six months’ reserves in place and untouched before considering the purchase of a real estate investment.”
Rental properties offer a lot of potential—after all, if you have a responsible tenant who is paying rent on time while taking good care of your property, that’s money coming in every month while your property simultaneously appreciates in value over the years.
But don’t think that investment properties are easy money by any means. Rental properties require that you, as the owner, must put capital into them on an ongoing basis to maintain them or even improve them to retain tenants. In the beginning, most of your rental income will go toward paying down the principal, so it could be 10 or 15 years before it’s producing money for you. “You have to work the investment in order for it to become something that really grows in value,” Kappel says.
Larissa Costello with Ad Astra Wealth Management refers to the idea of investment properties as a “buyer beware” scenario because of the risks associated with it, not to mention the responsibilities that some people don’t anticipate. “You’ve got to make sure you do your due diligence,” she says. “Are you prepared to be a landlord? Do you want to hire a property management company?” In some situations, she explains, a landlord gets a 3 a.m. phone call about a leaking toilet, and they have to handle that themselves or hire somebody to handle it for them.
Alsina points out that managing rental properties is essentially a business. “I recommend people looking to purchase investment real estate consider all the costs involved and be able to cover those for several months without any rent coming in,” she says. “If you have a period of time with no tenant, or a tenant who isn’t paying and now you need to go through the eviction process, you need to be able pay the mortgage, insurance, and property taxes without that rental income.”
The Single Best Investment?
Rental properties aside, even your primary residence has some level of risk associated with it that you should carefully consider. Maybe you’ve heard the advice that “the single best investment one can make is a home,” but that’s not exactly true.
Orso explains that between 2008 and 2015, he counseled hundreds of families through very tough financial decisions—and he says it wasn’t because the market had retracted but instead because these homeowners saw their lives change and they needed to sell. “The unaffected parties during the downturn were the families who didn’t need to sell,” he says. “The first and most important question when buying a home is actually ‘When will you be selling the home?’” Those who won’t be in their home for a long period of time should consider the shorter-term solution of renting, he says.
Costello agrees with this notion. “If you move in five years, the cost of buying and selling a home may not make sense,” she says, adding that people who are already under a lot of debt should not take on more than they can afford. “You always have to look at what debt you’re taking on,” she says. “Housing costs should be 28 percent or less of your gross monthly income.”
It’s also important to remember that some capital you put into the property will increase its value—new appliances, for example—but other expensive changes, while conducive to your personal lifestyle, might decrease the value of the home. “You should meet with a real estate professional if you’re planning to make significant improvements to the home so that you don’t put money into things that don’t have an ROI,” Kappel says. “People will buy a house for a million dollars and it’s a great investment at a million—it’s worth a million or more—but then they spend $250,000 on a fancy garage or something crazy, turning an asset that has equity and has value into something that’s overbuilt or too niche.”
Consulting a Professional
Whether you’re making changes to the property or not, or whether the home you’re looking to buy will serve as your primary residence or a rental property, it’s important to remember that your situation as an investor is unique. Your financial portfolio is going to be unique too.
Financial planners, investment advisers, and real estate agents can help you make the wisest decision. They know the industry—and more importantly, they can help you be objective about a purchase that you’re often putting a lot of heart into.
“Hire a true real estate professional to be your guide,” Orso says. “An experienced guide knows the risk, explains the risk, and has a roadmap for success. Bad decisions happen very quickly and the resolution to those decisions can last for years. Investing should be tactical not emotional.”
