Sunday, October 22, 2006

Why Real Estate Investing is Just Hype

This post is a counter to all of the hype surrounding the real estate “investing” world. It is now almost commonplace to hear ordinary Americans looking at real estate as an investment instead of a place to live. What they don’t realize is the deck is stacked against them in regards to costs & returns. Real Estate has suddenly turned into a one stop shop for all things including an ATM/Bank, children’s college savings, retirement account, etc. Well here are my problems with single family home dwellings as an investment properties (multiple properties) for most Americans.
  • Operating/maintenance costs are high: This is probably the most significant overlooked cost for investors. Yes there are interest & tax expenses and yes they are tax deductible, but it costs money. Plus your interest rates are going to be higher because the home is non-owner occupied. Then you have the choice of having a management company or yourself taking responsibility of your tenants and their needs. There is a cost which can range from 15-30% of your rental income. Or you can utilize your time and liability risk to do it yourself. Remember not all tenants are created equal and a horrible tenant can become an absolute nightmare and sap your time. If you bought an older property, be prepared to dole out some cash for major repairs.
  • Buying costs you time and money: This is also underestimated because most folks believe the costs are taken care of by the seller. Guess again they are some hidden ones. Most notably an agent will have a conflict of interest to only show their broker/companies listing. This can lead to paying more for a property. Also there is the costs of your loan which can range anywhere to 1-3% of the sale. The time spent buying house can be substantial when considering: looking at all properties, haggling with the seller on price & contingencies, and getting all of the inspections & paperwork done.
  • Selling costs you time and money: Here is what really gets you when you decide to finally sell your investment property. You will be looking at an agent’s fee of close to 4-6% off the sale to get listed and marketed. God forbid you have to sell in a market like 2006-‘07 or you can add closing costs to that fee too. Then of course there is the time and energy to get your house in shape and to show it constantly. Another little known issue is your house just got a couple years older, while newer and better houses are entering the market.
  • No capital gains tax breaks for non-owner occupied homes: This is the most glaring issue, especially for flippers. This will literally eat what ever profits you have left after the aforementioned costs. Your capital gain is going to be taxed at ordinary income rates. This means you’re going to be taxed at federal & state level from 25-46% on your gain depending on how much you income and if your state taxes you.
  • The returns are mostly based on extraordinarily high amounts of leverage: For almost everybody you have to be leveraged with a down payment of around 20%. In an up market that can turn a 5% home value increase to a rate of return of 20%. Well guess what happens if the home value goes down 5% when you want to sell? Now you have a 20% loss. Hmmm your value goes down 10% and you’re looking at 50% loss on your money. But housing always goes up right? According to Yale Professor Robert Shiller prices have only increased at rate of under inflation of 3%/yr. (the long term data is very difficult get a reading on because houses were much smaller in the 1950’s compared to now)

Again I am not advocating that nobody should invest in real estate, but that people need to realize that there are better investments out there instead of a 2nd or 3rd home. I believe real estate investing becomes more attractive if you are a real estate agent, mortgage broker, contractor, etc. because you are able to get some rebates into your investment. Also if this is your primary job, you do it on a daily basis, and you have the time to invest. Most folks are not able to dedicate adequate time to real estate because they have a regular job. A house is a place to live and homeownership is great for that. So lets all keep that in prospective.


FlyingMonkeyWarrior said...

What about buying now for a place to live? Find a FB and let him take the hit? Do you think we will loose 50% of the value of the home. In other words some people on HP think housing will go back to 2002, 2003 pricing. I think not. I believe that they will loos 40% of the last two year gain and then go back to peak o5 prices over the next five years, at worse. What do you think.

FlyingMonkeyWarrior said...

loose 40%, rather. Didn't spell check, just posted. (:

"Hunter" said...

I am all for buying a house when the fundamentals are within reason. The post was more for investment properties, 2nd homes, etc. Remember there will always be an ownership premium, so you just have to weigh out the options when you're looking to buy. If you can put 10-20% down, have a regular fixed rate loan, and the payments are do able then buying is worth it.

I think a 50% haircut is a little far fetched, but it is possible in some areas of Arizona, California, & Florida. I think Florida will be the hardest hit nationally. My predictions are 30-40% for bubbly areas and maybe 10% for the others. I also think this downturn will be long and slow. Your probably not going to see sudden giant reductions, but over time they will turn out to be quite large. Hope that helps!

FMW said...

Very close to my thoughs again, it is a relief after HP's gloom and doom.
Thanks, very helpful.