I have heard people say that the first home you buy should be an investment property. This seems very odd at first, but when you think about it, there is a lot of sound logic behind that statement. In previous posts we have outlined the true costs of ownership.
Real Estate market value only returns 1% per Year
One of the main reason is the opportunity cost of putting large sums of money in a home. Robert Shiller has won a noble price for his work studying housing and came to the conclusion that on average single family homes gain 1% per year in market value. This will be the return whether you live in it or rent it out. A lot of people buy a home to live in thinking it is an investment, but it should better be thought of as a consumption item that has a marketable floating price.
The difference between the two results in that the house you live in costs you money each month in mortgage interest, property taxes, insurance, and maintenance. The rental property, if managed well, will provide money each month in the form of rent (similar to a stock dividend) before subtracting operating costs. Now generally unless you can contract out a lot of the responsibilities you will have to spend some time managing it. Therefore, Investment real estate should be thought of as running a small business. The more work you do yourself the greater the return will be.
Now just because you can make profits renting our real estate does not mean there are not better investment options available. It is important to weight risk and return of all available investments. Therefore, the timing of the purchase will have a great impact on how well it performs just as would the timing of buying stocks and bonds.
If you have a strong believe in rental real estate being the best place to invest your money you may best be served by investing in REITS. These are companies that invest in hundreds and thousands of different types of real estate. This may include office space, retail, single family homes, apartment complex, and even trailer parks. You can buy ETF’s that own a mixture of all of the above. The benefit to reits is they are professionally managed. You do pay for this service as management costs are deducted from profits before any money is returned to shareholders. Depending on the company these fees can be quite reasonable due to economy of scale. They can hire employees to oversee many developments at once, think bulk discounts at the grocery store.
- Diversification! For most buying even a single rental property would be a big deal. If anything goes wrong with the house itself, the neighborhood, or bad tenants could lead to substantial lossed. REITS can have a few properties drastically underperform, but still turn a nice profit overall due to the large scale of its portfolio.
- Expert Professional Management. The individual real estate investor can have high and low levels of experiance. Either way it still would be a challenge to compete with the big boys so why not join them.
- Truly passive income.
- If you purchase rental real estate with a mortgage you will be employing leverage. Many REITS also are using loans on their properties so their returns are magnified as well, but likely not to the extend that an individual real estate purchase would.
- With REITS you cannot do work yourself to add value.