Is Real Estate Investing All That It Is Cracked Up to Be?

If you are someone who is focused on improving your financial IQ and learning more about investing, chances are good you have stumbled upon a book, podcast, radio show, or other educational resources touting real estate investing as the king of all investments. But is real estate investing all it is really cracked up to be? And just because it might be a good way to invest your money, is it the right investment for you?

An important point to understand when you become an investor is that there is not a one-size fits all approach. The types of investments you should make depend on your specific needs and a number of other subjective factors, such as the level of time you have available to spend and the types of things you like doing and don’t like doing.

Read more to find out the pros and cons of real estate investing to see if it might make sense for you.

Please note that we are not financial advisors or registered investment advisors. We do not give investment advice and encourage you to do your own independent research and seek the assistance of qualified individuals where necessary before making any investment decisions.

What Does Real Estate Investing Mean?

Real estate investing can take on many forms. It may mean you go out and buy properties yourself and then rent those properties out to a tenant. You can also own larger properties such as multi-family units, apartment buildings, and even hotels or motels.

Real estate investing can also be done passively through real estate funds, real estate investment trusts (REITs), or crowdfunding sites such as Fundrise or CrowdStreet. In any event, when we talk about real estate investing we mean all of these alternatives, regardless of whether you are actively managing properties you own directly or passively investing through some other means.

It is important to remember that the different ways of investing all work very differently. The money needed, level of time commitment, and requisite knowledge needed can vary significantly depending on which method you are considering.

Who is Talking About Real Estate Investing?

When you are researching real estate investing and how to do it, it is important to remember one thing – all the people talking about it are professional real estate investors. In fact, all of the podcasts I listen to on real estate investing (and I listen to a lot) are all hosted by real estate syndicators.

Real estate syndicators are individuals who manage real estate funds by pooling investments from various investors into a fund. Once the money from the investors has been received, the fund will then purchase real estate properties for investment purposes. The syndicators or fund managers stand to make a good bit of money if the deal goes well, and in some cases even if the deal doesn’t go well.

That means that the person teaching you about real estate investing stands to gain financially if you, as a listener, become an investor in their fund. So they have every incentive to talk up real estate investing and make it sound like the best thing next to sliced bread. There is a clear conflict of interest here.

Nonetheless, that doesn’t mean you shouldn’t listen to what they have to say. The best real estate syndicators are probably the best people to learn from because they do this for a living and would have the most knowledge and experience. I am certainly not saying don’t learn about real estate investing from these syndicators; just be aware of the need to take what they say with a grain of salt and understand that your situation may be drastically different than their situation.

The Truth About Real Estate Investing You Won’t Hear from the Professionals

Given that most of the information you will hear about real estate investing is from real estate professionals, it is important to point out a few often overlooked points you should keep in mind.

• To actively invest in real estate and become a real estate professional might mean you need to make real estate investing the main focus of your time and energy.

To really make bank from real estate investing in the same way these real estate professionals do, it is quite likely that you will need to spend a great bit of your time on the endeavor. That could mean giving up your day job or spending less time on your other businesses or investments.

It is always important to never lose focus of what is the best use of your time. If you might make more money from spending your time on other sources of income, it is probably a good idea to put more focus on that.

• It is highly unlikely you will make anywhere near as much money as they do from investing in real estate.

Real estate professionals almost always make money from several different sources involving the investment. For example, a fund manager will typically receive many different types of fees such as finder’s fee for any properties acquired by the fund, closing fee for any properties sold by the fund, property management fees for managing the properties themselves, and a fee for managing the fund.

That means a large portion of the money made by the fund manager doesn’t even come from the ownership of the properties. Stated otherwise, the fund manager is making a lot of money from sources that you as an investor in real estate will not be.

• They often stand to gain financially from you investing in their funds.

I mentioned above how most people talking about real estate investing are syndicators. In some cases, the individual may not be a fund manager themselves, but they are a principal of the fund, meaning they will receive a monetary benefit if you decide to invest. That isn’t to say don’t listen to the advice they give. It just means make sure you are always aware of this potential bias in their advice.

1. Tax Benefits

From a tax perspective, there is no better investment that you can make than real estate. The tax laws in the U.S., and most foreign countries, are extremely favorable to real estate investors. This is largely due to the ability to claim depreciation deductions against your income.

If set up properly, you should be able to offset all income and show a net loss for tax purposes, meaning you will owe no tax on the income you receive from the property. In some situations, you may even be able to use tax losses from your real estate investments to offset income from other sources. There is also the ability to defer capital gains tax when you sell the property in some cases.

The number one benefit from real estate investing is the tax advantages that come with it. This is why some of the ultra wealthy (such as President Donald Trump and Robert Kiyosaki) amass large amounts of wealth from real estate investments while legally paying little to no tax.

2. Ability to Use Debt Leverage

Another benefit from real estate investing is the ability to use debt to fund the purchase of properties. You can and should always use as much good debt as possible to acquire assets. Banks are always willing to lend against real estate because if things go badly and the lender can’t pay back the loan, the bank can come in and foreclose on the property. So the risk to the bank is relatively low.

Because of the low risk involved with real estate lending, you can typically get a loan to buy a property at low interest rates, certainly lower rates than are available for more risky investments such as acquiring a business. The downpayment required is also low and in some cases, you can buy a property by putting down as little as 10%-20% of the purchase price.

3. Cash Flow Potential

We all know cash is king. Cash flow investing is always preferable to investments in assets that do not produce cash flow. Because you can rent out the properties to a tenant in exchange for rental income, you will earn cash flow on your investments. The cash flow can be used to offset any expenses associated with the property as well as pay down the mortgage with the bank. If set up properly, the properties should pay for themselves through the rental income.

In addition to the cash flow, you will hopefully also experience gains from appreciation of the property over time. That means when you sell the property in the future, you may have another payday from the appreciation in the value of the property over what you originally paid for it.

4. Steady Asset Class

We will always need places to live. In that sense, real estate is generally thought to be one of the safer asset classes. Unlike owning stock in a company that could go bankrupt overnight, your property should generally be relatively stable. Through insurance and other means, you can also protect yourself against any risks to the building and structures themselves.

Be careful here though because, just like any other asset, property values can decrease. We need to look no further than 2008 to see that the value of real estate can go down just like everything else. In some areas of the U.S., those values still have not returned to their pre-2008 values yet.

You also want to be very careful about where you invest because the demand for real estate will decrease as people leave the area. We are seeing this happen now as there is a trend of people moving from high-tax states to low-tax states in the post-COVID world.

5. Passive Income

Unless you are an active real estate professional, real estate investing can be done in a way that generates passive income. You can achieve decent returns and recurring monthly payments if you know what you are doing. This can be done a number of different ways, including by using a third-party property manager, putting a good staff in place, or investing in real estate funds.

Cons of Real Estate Investing

While there are many benefits to real estate investing, there are some downsides which are often not talked about as frequently. Make sure you fully understand these cons before making any investments so that you can tailor your approach accordingly.

1. Total Returns Can Be Low

When you make any investment, you have to understand the actual return on that investment. That means taking into account everything, including the tax benefit associated with that asset. When you are modeling the expected return on any real estate investments, make sure you factor in the expected tax savings that would not be available with any other types of investments.

With that said, real estate investing will rarely result in large returns. In some cases, you may not receive significant positive cash flow until you have fully paid off the mortgage on the property. That may be 20 or 30 years in the future, depending on the term of the loan. I don’t know about you, but for me that is too long to wait for me to start seeing a tangible return to my investment.

Although you should always be investing for cash flow, the appreciation in real estate over time often does not keep up with other asset classes. In many cases, the appreciation in real estate doesn’t differ much from inflation. That means your actual appreciation is zero.

Per the Case-Shiller U.S. Home Price Index, the value of homes in the U.S. has increased at an average rate of slightly more than 3% a year since 1891. That is a really, really bad rate of return. For comparison, the S&P 500’s average rate of return was 13.6% for the past 10 years.

2. To Make Money You Need A Lot of Money to Start

There is one thing I have noticed about the uber-wealthy real estate investors – they either started with a lot of money or they have made most of their money from other sources. Just like running any other business, to make a lot of money investing in real estate, you need to be able to scale. This means, you need to be able to own several properties that are all rented out and earning you money at the same time. To achieve scale in real estate in a big way, you need a lot of money.

Another point to reiterate is that, as I mentioned before, all of the successful real estate investors I know personally are all real estate syndicators, which is a very different business than just going out and buying up a few homes you can rent. That means unless you are prepared to start getting involved in real estate syndications, it is highly unlikely you will achieve anywhere near the same financial returns the fund managers get.

3. Vacancy Periods

The success of the investment is almost completely dependent on your ability to find a tenant to rent the property. There will almost invariably be periods where your property sits vacant. It is critical that you take this risk into account and include in your model the impact potential vacancy periods could have on your overall returns.

4. Competition with Institutional Players and Lack of Good Deals

It is getting increasingly more difficult to identify good investment opportunities in this space. A big reason for this is that institutional investors are acquiring the best properties off-market. That means the big players in this space are able to snag up the good deals before you ever even hear about the listing.

Smaller deals can also be hard to come by even if they don’t attract attention from the big guys. That is because if someone else already owns the property and that property is cash flowing and producing good returns, the current owner has no reason to sell.

The likelihood that you will find a good property for sale with a tenant in place that pays enough rent to offset all the costs and debt service is about as likely as seeing a unicorn in the wild. It just doesn’t happen.

That means if you want to start building up a portfolio of properties, you are going to have to do a lot of work looking for potential homes to buy, refitting the home so that it can be rented, finding a tenant, and putting a system in place to manage the property going forward. That can be a lot of work and mean it will take a long time before you can really do this on a large scale!

Should You Start Investing in Real Estate?

The extent to which it makes sense for you to invest in real estate depends on your specific facts and circumstances. No one can make that decision except you. However, what I hope you understood from reading this article is that real estate, in a lot of cases, is much more complicated than many make it out to be.

While there are several benefits to real estate investing, there are also some pretty big drawbacks that you need to keep in mind. Before you get started, think through how you want to invest and which method of investing might be right for you.

Always remember, there are ways to invest in real estate passively that don’t involve you plunging toilets at all hours of the night! I personally have always preferred investing in real estate passively, meaning I do not actively manage any of the properties I own myself.

The best use of your time is focusing on what is going to make the most money. Keep in mind, that is quite often not likely to be real estate investing. Therefore, consider finding ways to incorporate investments in real estate into your portfolio that don’t involve you actively managing the properties yourself.