Is this the right time to get into real estate investing?
For many Corridor Funding clients actively growing their real estate portfolios, the answer is a resounding yes. But some skeptics disagree. For example, this recent article cautions investors against real estate in the current climate, pointing out the possible downside of investing in real estate, especially compared to the stock market.
Calculating real estate investment risk is part of any savvy real estate investor’s process. But while it’s always necessary to consider the potential risks before making any investment, do your homework and listen to trusted resources to understand the real costs and benefits.
Here are some of the most common concerns about investing in real estate right now and the Corridor Funding team’s assessment of each one.
MYTH: A limited supply of single-family and multi-family residences make it a bad time to purchase an investment property.
REALITY: Limited supply is one of the things real estate investors look for most when considering investing in a market. When supply is limited and prices are high, it means that demand is high as well. The inverse of limited supply is high Days on Market, which is a sophisticated investor’s worst nightmare. Whether you are going to be flipping or renting out your property, a high DOM means you can do everything right but can still lose. From extended carrying costs to high vacancy rates, investors have to consider the implications of supply levels on both sides of their investment, not just when they purchase.
MYTH: Soaring home prices mean it’s a bad time to buy.
REALITY: Rising home prices are a great thing for real estate investors! Sure, the house you want to invest in costs more than it did last year if you would have gotten in then, but the expectation is that the same house will be worth more a year from now as well. The alternative to this is investing in a market with declining prices. This was a huge gamble that very experienced investors took after the 2008 market crash, and for some, it paid off big, while others lost everything. Timing is everything in real estate, and you have to avoid getting caught in a bursting bubble, but riding the wave of rising prices is just smart investing.
MYTH: Don’t invest now because inflation is looming on the horizon.
REALITY: There’s virtually always some degree of inflation happening in any market. With the outpouring of stimulus money over the last year, some economists are anticipating additional inflation, though no one knows when and how much. The inflation rate may go up, but investing in properties and taking on long-term debts is a hedge against inflation. When you get a fixed-rate loan, inflation will increase the rents an investor collects simply because inflation causes the cost of living to increase. However, the monthly loan payment never increases. Every year that there is inflation, the investor’s cash flow goes up. With a 30 year loan, you could be collecting rent in 2021 dollars, but only paying your mortgage expense in 1991 dollars. Real estate typically outpaces inflation, making it an ideal hedge for any amount of inflation.
MYTH: Real estate investments are risky because they’re not liquid.
REALITY: Real estate is not as liquid as stocks or bonds, but it has also never been worth zero. By planning well and having realistic expectations of your investment and your market, a savvy real estate investor can mitigate most of the problems with a less-liquid investment. Investors that aren’t taking a long-term approach to real estate investing put their money into flipping houses. A good flipper can be in and out of a light rehab in as little as 90 days. We have had borrowers pay back loans in as few as 7 days by ‘wholetailing,’ where an investor buys a property below market value and simply cleans it up, and then lists it on the MLS.
MYTH: Real estate transactions carry extra costs that limit profits.
REALITY: Costs are part of any investment. The real estate carries different costs, not necessarily extra costs. Investing in a mutual fund, for example, can cost upwards of 1.5% per year, regardless of performance. The typical hedge fund fee structure is 2 and 20, or a two percent fee each year and a 20% fee on profits. In real estate, transaction costs are known and can be modeled into your investment outlook. If the risk and returns of two different investments were equal, then you would of course choose the one with lower transaction costs. But our investors typically see 30% or higher returns on their investment. A 30% return on investment after paying 10% in transaction fees is still better than a 10% return with no fees!
MYTH: Your property may not be tax-deductible.
REALITY: This might be true if you are considering your personal residence as an investment, but serious real estate investors are running a business, and any business expense reduces your taxable income. Mortgage interest may not be deductible on your personal taxes if you don’t itemize your deductions; however, if you own the property in an LLC, the interest expense is absolutely a deduction because it is an expense. You may also be able to deduct other business-related expenses that you wouldn’t be able to if you were only passively investing in the stock market, for example.
MYTH: Real estate investments are risky because they are highly leveraged.
REALITY: This is the best part about real estate investing! You are able to use leverage to stretch the value of your dollar. Instead of buying a $50,000 house in cash that may make a rental income of $400/month, you can use that as a down payment on a $250,000 house that makes $2,000/month. Even after you take out the cost of the financing, the leveraged deal makes a much better return! Unlike buying stock on margin, you are never in danger of your real estate investment losing all of its value.
MYTH: Unlike stocks, real estate pricing is highly variable and full of unknowns, making investing more complex.
REALITY: Anyone who argues that the market cap of a publicly-traded company is a 100% accurate representation of its real market value hasn’t been watching Game Stop trading recently. When comparing real estate prices to stock prices, remember to factor in time. What you can sell a stock for today is easy to know. But what you will be able to sell that same stock for in a year from now is anyone’s guess. There are so many things that influence what that stock will be worth, and none of them are in the investors’ control, which makes knowing the future value of a stock a lot more difficult than estimating what a house will be worth after you complete your renovation. Real estate pricing is simple: the price is the highest amount a buyer is willing to pay. Knowing what the actual number will be is more difficult, but again goes back to the investor’s experience and skill.
MYTH: Investment properties require a lot of work from the property owner.
REALITY: Some investment properties require a lot of work, but there are also completely passive real estate investments and everything in between. Saying that all investment properties require a lot of work is a broad generalization, though the more work you put into it, the healthier your returns tend to be. Not unlike investing in the stock market, a large portion of the ‘work’ a real estate investor puts in is research and knowing your market. There are no free rides and real estate is no exception, but the rewards outweigh the risks for the hundreds of investors we work with on a daily basis.
Ready to discuss your next project with a local market expert? Contact Corridor Funding today!
KEY TAKEAWAYS FOR REAL ESTATE INVESTORS
- Don’t be scared away by a hot market. Limited supply and higher prices for single and multi-family residences mean that demand is high as well.
- Real estate investments can be smart in a period of higher inflation.When inflation rates go up, real estate investments can be a hedge.
- Plan well and have realistic expectations.When considering any investment, factor in the expenses, impact on taxes and time horizon.
- Leverage is one of the best parts of real estate investing. Leverage stretches the value of your dollar and lead to higher returns, even with the costs of financing.
- Research and know your market. Some investment properties require a lot of work, some are more passive, but the rewards can greatly outweigh the risks, especially when you have a good team on your side.