In part 1 of this series I showed you why you shouldn’t buy a house. In this article I want to show you why you shouldn’t invest in real estate, some of the arguments carry over so make sure to read part 1 before you read this article, but there are issues specific to investing that you need to know.
Investing in real estate isn’t the sacred cow that home-ownership is, in fact many people look at it as a risky proposition, which it is but I respect any guy that’s got his mind in this direction because chances are he’s looking for passive income and getting out of the rat race, two things we absolutely support here.
Many men have built fortunes off of investing in real estate and the possibility of financial freedom is absolutely there but with it come risks, time, costs and friction, there are better ways to make money. Like we did in part 1 I’m going to debunk the most common reasons people invest in real estate and add some more key points to hammer it home.
Reasons Why People Invest In Real Estate
1) Passive Income
Many guys looking for a way out of wage slavery have realized they need passive income and I absolutely agree. Unfortunately landlording is not passive and in many cases, not income at all. Every property will have problems to deal with. Appliances break down, leaks need to be fixed, vacancies need to be filled, multiply those problems by how many properties you own and you’ve got a lot of problems.
You can hire a property manager but that cuts your margins even thinner. Despite what most real estate investment salesmen tell you cash flow is often a myth, if you’re breaking even you’re doing well, if you can make $100 a month you’re doing very well. Compare this to the smallest internet business where you can easily cash flow $100 a month while you sleep.
If you walk into a bank and ask for 500% leverage to gamble on penny stocks they’ll look at you like you’re on bath salts, and rightfully so, yet but if you tell them you want to gamble on the housing market they are more than happy to put you into lifelong debt.
A lot of guys get into real estate because it’s the only type of investment where they can get access to that kind of capital and want they to take advantage of those magnified returns. As we covered in part 1, leverage magnifies, its great when the market moves your way and a disaster when the market moves against you which can easily wipe out your equity.
I respect any guy who’s willing to take those risks but when you build a leveraged house of cards like a real estate portfolio, you’re always just a few steps away from it falling apart. If I was going to use leverage, I’d rather use it on something I can control, like my own business as opposed to something I can’t like housing prices. Or better yet, bankroll a low cost business to enter where I risk my time instead of my money.
As we covered in part 1, appreciation outside of a bubble is largely a myth, the reality is the bulk of appreciation is caused by inflation which gives the appearance of rising house prices. Houses will appreciate but compared to stocks or bonds they are the least appreciable asset class and the worst investment.
Robert Shiller, creator of the Case-Shiller housing index has shown that real gains in housing since 1890 adjusted for inflation only amount to 0.2% a year on average. Compare that to the S&P 500 index which on average has returned 8% a year. Housing has a lower appreciation rate than even the most conservative investment, treasury bonds.
4) Someone Else Pays For Your Asset
This can be true when you have good tenants, low vacancy rates and are in positive cash flow. When you have problem tenants, a high vacancy rate and negative cash flow you can easily be going in your pocket every month for hundreds of dollars to cover the costs.
5) Real Estate Scams
Many guys get exposed to real estate investing from an “expert” through a free seminar which is really just a high pressure sales pitch masquerading as an information session. Participants are pressured by the scam artist to sign up for more courses, seminars and mentoring all at a hefty price tag where the majority of the information pitched is either a product or easily available online.
These “gurus” also pitch joint venture clubs where you invest with the guru who will give you ready-made deals and their “expertise” in exchange for your cash. Common selling feature include higher rental rates, the ability to buy properties on a discount and passive no-headache income but all you get is shady deals and your money in the guru’s pocket.
I’ve worked at a company that published a real estate investment magazine and a series of real estate events, there are some legitimate real estate advisors but the majority of the guys in that industry are scammers, guys I wouldn’t buy a cup of coffee from.
6) House Flipping
House flipping is a decent option for guys who are seasoned negotiators with lots of home improvement skill, time on their hands and decent savings but its a sh*tty option for the average guy with no skills, little free time and lots of debt. It means you have to go out of pocket for the renovations and if you’ve overpaid your flipping strategy is now worthless.
House flipping is a part time job at the least and a full time job if you’re serious, its involves a ton of friction and headaches that can be avoided in other businesses or investments. You also have to factor in all the transaction costs that you could have amortized on a longer time frame like agent’s commissions, the real estate transfer tax, escrow costs and carrying costs while the property is being remodeled.
In the wake of the housing crash we’ve also seen increased protection for distressed sellers and warranty requirements for renovated homes. These changes cut into profits for flipping houses because they limit the ability for you to find discounted property and increase your expenses to meet standards for renovating the property. Another downside to house flipping is selling a home that you have owned less than a year will result in the gains from the property being taxed as ordinary income as opposed to capital gains tax at 15%.
7) Housing Is Safer Than Stocks
This was a common myth for many years until the housing crisis destroyed that idea. Its true house prices don’t fall to zero like stock prices, but your equity in a house can easily fall to zero and below because you bought on leverage. It just takes prices to drop 10% with a 10% down payment on the house and you are completely wiped out while still owing the bank the purchase price you borrowed at plus interest.
With stocks its true that they can fall to zero but if you’ve held your shares to zero you’ve made a massive error, getting into a position without a stop loss is a terrible way to invest. Also chances are you didn’t have 500% leverage on your stock portfolio because the bank would never loan you that kind of money to gamble with. And with stocks lets say your shares drop 5% you can sell immediately with no friction.
Try doing that with a house and get the price you want. Housing is no less risky than stocks and with the amount of leverage generally used, it’s actually a much riskier investment.
8) Tax Breaks
A lot of guys think they can take advantage of tax breaks through buying properties, unfortunately many of those breaks don’t extend to investors and the ones that do, don’t justify the investment. The mortgage interest deduction is a great benefit for property owners but is offset by property taxes which you wouldn’t need to pay on other investments like stocks or bonds.
The deduction has also become vulnerable lately with the Obama administration debating whether it’s still feasible. If you take a loss on the sale of your home you can’t deduct that whereas with stocks you can deduct your losses against your gains.
Or ,If you lose money in your portable online business, you can deduct all your losses against gains in future years. Investors also don’t qualify for the tax exemption for selling a home because you have to have lived in the property as your primary residence for 2 out of 5 years.
Reasons Why You Shouldn’t Invest In Real Estate
Owning multiple properties is not passive income, managing properties will take up as much time as a part-time business, except the payout is on the deferred life plan as opposed to an actual part-time business that could be paying you now.
Expect to have issues with your properties 4 or 5 times a year with a couple of those being major events. In one year an ex-colleague of mine had to deal with two separate issues with his property in England, one of them being a robbery, with him flying back both times.
The rest of his free time, went to his other two properties here in Toronto, whether it was fixing a chimney or installing a new fence, every single weekend he had a time-consuming project. Luckily he’s very capable at fixing things and has a great work ethic, but with a family and a full-time job to contend with he has no free time. He’ll have a nice nest egg to retire off of in his 60’s but until then he’s an exhausted corporate slave.
2) Opportunity Cost
We covered opportunity cost in part 1 but I want to reiterate that when you dump all your savings into multiple properties you’re still on the deferred life plan. It’s true that if you’re sharp, a shrewd negotiator have access to lots of capital, are lucky, extremely hard working and capable of doing repairs yourself then you can be financially free.
The problem is, it might take you 10 or 20 years to get there unless you utilize extremely aggressive financing and acquisitions. Even if you’re a phenomenal investor and can cash flow $2000 a year from each property, you would need 20 properties to pay your basic expenses.
Until then you’re still slaving away in corporate America and spending all your free time trying to build up your house of cards. Investing in real estate might accelerate your timeline to liberation but it’s not quick enough, do you want to work a corporate job for the next 20 years? You can take that money and put it into a business that’s going to feed you two years from now or use it to pay your basic expenses while you baseline an online business from a cheap country.
Owning multiple properties means lots of maintenance, and if you want to attempt to cash flow you’ll probably have to cut out the property manager. That means time and money. You’ll never have to repair an index fund or an online business.
Insurance is similar to maintenance in the sense that owners must insure a house, but not stocks, bonds or your own business. Just another added expense and more friction with every new property.
5) Vacancy Costs
Vacancy is a hidden cost that you don’t have to worry about when you’re the sole owner of the property. But when you’re renting a property even one vacant month can easily wipe out your entire profit for the year or put you in the red.
Landlording is a business where your tenants are your clients, it takes salesmanship and relationship management. It means you have to deal with people and people are headaches, especially when they can potentially damage your livelihood and personal property.
What You Should Do Instead
Every single man on the Forbes list is a business owner, you can’t get rich as an employee and the longer you stay one the longer it will take you to start compounding your money in a business. You want the business with the least upfront costs, and the highest potential returns.In our grandfathers’ day, real estate might have been one of the only avenues for a man to liberate himself but in this day and age we have options, if you want to go bricks and mortar you can start a service based business where all you need is a phone, internet connection and sales skills.
But how can you compare anything else to owning an online business ? Yes there are a million guys doing it but most of them are lazy and stupid. For a sharp guy with a ruthless work ethic there is no way you can’t make money online with a decent idea at a fraction of the cost of starting any other business. That’s an opportunity our grandfathers would have killed for. Invest in yourself.