by dr. James M. Dahle, founder of WCI
I’ve never been a big fan of ‘hype’. I’m quite a dull, quiet person in that regard, but I believe that good investing is generally boring investing. My excitement in life comes from exploring the world, climbing, diving and other fun activities – not my portfolio. As a general rule, when investing is exciting and exciting, you run a high risk of losing money. Those who want to make it exciting usually sell something.
When an investor first encounters the real estate investing world, they are often surprised by the amount of hype they encounter. Sometimes it looks more like the annual meeting for a multi-level marketing company than anything else. There’s banging music, testimonials of the success and lots of encouragement that YOU can do it! Some people like that environment, but it can be a turn off for others. I think it’s worth looking past it rather than abandoning real estate just because of the hypey, rah-rah, cheerleader nature of its proponents.
However, there are three important lessons to learn from the hype, and they go a long way to explaining why it exists.
#1 Real Estate Investing Is Hard Work
Ask yourself, “Why do people need to be motivated to invest in real estate?” Well, reason No. 1 is that investing in real estate is hard work. Talk to any experienced direct real estate investor, and they’ll give you all sorts of ways they’ve been hunting. No one needs to get a motivational call to sit on a beach in Cancun. Or to sit on the couch and watch Netflix with a beer and a bowl of popcorn. Investing in real estate is not like that. Think about all the things you need to do to be a successful real estate investor:
The point is clear: investing directly in real estate is like a second job. It doesn’t take a lot of property before it becomes a full time job. Of course, all the above activities can be rented out. There are costs associated with this that lower the return, but the more you rent out, the less hard the work becomes. To see also : Zak Najac and David Cohen establish Mavrik Real Estate. But as long as you are the sole owner, you still have to supervise those who do the work. You can completely avoid most of the work by investing passively, but there will still be some work of selecting and controlling the investments or at least the sub-asset class and manager. Of course, there are also costs associated with being a passive investor, not the least of which is dealing with multiple state tax returns and paying significant fees to those who do the work for you.
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#2 Real Estate Investing Is Risky
Another reason there is so much hype around real estate investing is to encourage you to take significant risk. While part of the return comes from the tax breaks and paying off the mortgage, the two main sources of return from investing in real estate are the income (technically net operating income) from the property and the appreciation of the property. The two biggest risks of investing in real estate are that something will happen to those two sources of return:
Income Goes Down or Even Negative
There could be vacancy, tenants could stop paying, costs could rise, repairs could be needed, property taxes could go up, and more. All of this reduces that net operating income. To see also : What is home appreciation in real estate?. You run a business here and you have to be good at it.
Appreciation Disappears or Property Depreciates
Properties fall in value from time to time, especially when considered on “real” terms after inflation, and sometimes they fail to appreciate for very long periods of time. Keep in mind that most real estate value indices are not adjusted for people trading in older homes for new homes. The actual valuation rate of older homes (i.e. the home you now own as a real estate investor) isn’t nearly as impressive. Consider a select example: Detroit. The appreciation rate in Detroit since 2000 has been 0. See the article : Compass Comes back to Earth.23% per year. Average inflation has been 2.43% since then. After inflation, the average home bought in Detroit since 2000 has fallen in price by a cumulative 31%+. And that doesn’t explain the fact that many of those new houses were built after 2000. Imagine if I had chosen the time period (2006-2007?) in addition to the location. Nine years later, I sold the property I bought in 2006 at a significant loss, not counting the negative cash flow. And it wasn’t even in Detroit.
Leverage
There are additional risks in real estate. One of the most common risks real estate investors take (and are certainly encouraged to take those hypey books, conferences, and courses) is leverage risk.
“Get as much cheap leverage as you can!”
Leverage certainly increases returns. The problem with leverage, of course, is that it works both ways. Imagine if you put only 20% on a property and it drops in value by 31% over the next few decades. Your entire initial investment has been wiped out and you have wasted a ton of time and effort on that property. Another annoying part of leverage is that, at least when investing directly, you usually personally sign for any associated debts. That means you can lose more than your entire investment. A return of -100% is bad enough. A return of -300% is particularly painful.
Illiquidity
Real estate is also usually a very illiquid investment with high transaction costs, even if you invest passively and even if you invest on the more liquid debt side than the less liquid equity side. You MUST be paid more to address that illiquidity. If a boring old REIT index fund can offer 9% returns with daily liquidity and no hassle, why would you ever buy your own property or go into an illiquid private syndicate for the same returns?
Investing is mainly about risk management. If your source of information on real estate investing doesn’t delve deep into the risks of real estate investing and how to carefully manage them and make sure you’re compensated for the risks you have to take, then keep looking.
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#3 Beware the Shovel Sellers
I have spent most of my life in the western United States, including Alaska. Part of our history here includes countless gold rushes and the interesting characters they attracted. Historians will tell you that those who got rich in a gold rush were generally not prospectors. Those who got rich sold the shovels (and the food, housing, drink and supplies) to the prospectors.
In the real estate world, there are many people who sell spades. They have a serious conflict of interest to get you super excited about real estate investing, to learn more about real estate investing and to try it for yourself. Also the spades they sell are often gold plated. I’m amazed to see people who can’t afford to pay a few thousand dollars for a real financial plan, who wouldn’t mind paying a six-figure real estate coach to learn their secrets. Real estate courses and conferences are routinely the most expensive I’ve seen. If you question or negotiate the price, you will be accused of “a scarcity mentality.” If the courses or conferences are free, you must be wondering why anyone would go to work to host a conference with no upfront cost. You’ll quickly find that YOU are the product at that event, or that the real sale will be AT the conference, not before the conference. Just as those on Wall Street are notorious for transferring wealth from your pocket to their wallets, there are plenty on Main Street who would like to do the same. Consider the following shovel sellers:
All those people have a conflict of interest to get you excited about being a landlord and about real estate investing in general. They want to sell you the shovels to dig for gold. Be careful not to buy too many gold plated ones and realize that they always make money (and sometimes a lot more than you do) whether you do it or not.
When you encounter the real estate hype machine, remember these three reasons. If you can see through the hype, do the work, manage the risks, and watch your costs, you can still get excellent returns investing in real estate. Just don’t expect a risk-free, effortless, fast path to unlimited wealth.
In an effort to help you be successful in real estate investing, we are in the final stages of a new WCI online course called “No Hype Real Estate Investing”. It’s coming out soon.
Don’t forget to sign up for the free White Coat Investor Real Estate Newsletter that will alert you to opportunities to invest in private real estate syndications and funds, including most of those I invest in.
What do you think? Why do you think there is so much hype around real estate investing? What should the individual investor do about it? Is some of the hype good or helpful? Why or why not? Leave your comment below!
