The Myth of Passive Real Estate Investment

At my financial planning firm, we focus on serving clients in their 30s to 50s — and see firsthand how popular the idea is that real estate is a way to get rich (relatively) quickly. That would be fine if real estate was a passive income maker that doesn’t need to think the way many people think. The problem is that the narrative does not match the reality.

While real estate Can Be a good investment, as this statement comes with a list of caveats. All the “ifs” and “buts” that surround it mean that investing in real estate (especially with the goal of generating passive income) is more of a myth than a viable strategy for most people who simply want an easier or more exciting way to grow wealth than investing in the stock market on Long term using a diversified portfolio.

Before you join the ranks of novice real estate investors who understand just how much skill and luck is required to break even – not to mention make a profit – consider the following real estate investing facts first.

1. Rental property management requires a lot of work

When people tell me they want to invest in real estate, here’s the scenario they usually imagine: They receive a rent check on the first of the month, every month, which is much larger than the mortgage payments on the property. Then they use the check to pay the mortgage, cover all homeownership costs, and then pocket the profits.

It is possible to identify, buy and manage a rental property that will allow this dream scenario to come true. But it’s not for everyone, and it’s not a passive endeavor as many people imagine.

Unless you are ready to:

• Advertise to find tenants and avoid vacancies.
• Show the property to interested parties when looking for new tenants, and help maintain it for existing occupants.
• Vet applicants to ensure that you have qualified and reliable tenants.
• Constantly update and improve the property so you can continue to attract higher paying renters.
• Respond to maintenance requests and coordinate repairs (or do them yourself) in a timely manner.
• Manage all financial obligations, from paying bills to handling security deposits and more.

…then playing the landlord may not be the ideal role for you. All of this requires serious time and effort, and that’s exactly what you can plan for. Ask any seasoned real estate investor who manages properties with tenants their unexpected to-do list, and they’ll tell you about wildly over-budget repairs, evictions and tangles with the court system, or other rent-mistaken horror stories.

Of course, you can just outsource the headache and use a licensed property management company. This is a viable option and one that many serious real estate investors use. But that leaves less room for profit, considering that a standard property management fee can be as high as 10% of your monthly rent.

Compare all this to investing in the market, where you may not have to do any work at all if you set up an automated contribution to your investment accounts that works on the same day of the month, every month.

2. Just because it’s a house doesn’t mean it’s a good rent

Again, none of this tells you I can not Earn money by buying and then renting real estate to earn rental income. This is not the legend. The legend is that anyone can do this with Which The property they buy and offer for rent.

Unfortunately, it is not that simple. Learning to assess the investment potential of a rental property is much more involved than most people who simply want to buy a single-family home that they personally enjoy living in tend to think.

While there are some simplified formulas, such as the 1% rule – which says the rent you can charge on a rental property needs to be equal to 1% of that property’s purchase price for it to be a good deal – they are too generalized to be strict rules for success.

This is especially true in the unusual real estate markets as we’ve seen over the past couple of years. Bloomberg recently reported that in the third quarter of 2021, the median investment property price was $438,770. Using the 1% rule means you’ll need to charge $4,400 per month in rent for this property. Most markets will not support this type of rental for a medium-sized single-family home.

This is just a simplified arithmetic process. It does not take into account any of the other factors that need to be properly evaluated before you can determine if a particular property is a good candidate for investment. So yes, you can buy a house over $400,000 and rent it out. But if the whole idea of ​​real estate investing is to earn a return, you may face an uphill battle to make it happen. Again, this underscores the fact that buying real estate is not a ticket for quick and easy cash.

3. If you really want to invest in real estate, you probably don’t want to live there by yourself

It also doesn’t account for the background math to determine what might work for hire in our scenario Many Who are people talking about when they say they want to invest in real estate: what they really want is to buy vacation property, use it themselves for part of the year, and then rent it out when they’re not using it personally.

What they don’t consider is the fact that the home they personally wish to live in or use is likely to be more luxurious than the home an actual real estate investor would consider purchasing. The higher the price of a home, the harder it is to actually make a positive return.

And while vacation rentals can make for a quick business, if You are If you want to use the house for yourself during peak seasons, you will find it difficult to rent the house at a premium rate, fill vacancies in the off-season, or both.

Remember that seeing rent payments really do come in Not Automatic gain equalization. To determine whether you are truly earning a return on a property equal to or greater than what you can expect with a diversified portfolio invested in a range of mutual funds and ETFs, you must calculate your total internal rate of return – which requires taking into account All Homeownership costs, not just the top line numbers on your mortgage statement.

4. Buying real estate can be a distraction from your actual goals

Many clients have told me that they want to explore buying real estate as a way to grow their wealth, so I ask a very simple question: Is managing a portfolio of rental properties something you actually do? Wants to do?

With demanding jobs and growing families, the last thing most of our customers have is plenty of time, energy and hundreds of thousands of dollars begging to use for another home. Managing the role of owner or dealing with a relationship with a property management company is usually not what most people would like to take on, as it has nothing to do with their stated values, priorities and goals.

In fact, because the purchase of real estate requires a large amount of capital, it often detracts from other goals that they have. It can also swerve away from a comprehensive long-term investment strategy if it leaves you in financial distress and unable to invest in the market. Remember, you can invest in real estate Across Market through real estate investment trusts, or REITs.

You can only answer if committing to a real estate portfolio is a good use of your time and money, and if it is worth taking money away from other goals in order to fund this endeavor.

5. Real estate investing requires a team of good professionals

Bloggers and podcasters tend to make real estate investing deceptively simple, so it’s easy to think you can handle it all on your own. But the truth is that real estate investing is complicated. There are legal and financial dynamics in place that will likely require a team of trusted professionals to help you protect yourself and your investment.

We live in a society happy with lawsuits, which makes protecting yourself and your assets from potential liability extremely important. An informed insurance broker and trusted real estate attorney are non-negotiable for real estate investors. If something goes wrong with your renters or property, you’ll want these people in your corner.

The financial landscape in real estate investing is different from your personal finances. So having an accountant, tax expert, and financial advisor skilled in the terrain are also important components of a well-equipped real estate investment machine. It is important for the success of any new real estate investor to build and nurture these types of relationships.

Real estate investing as passive income: Know what you’re getting into

Yes real estate investment Can Being profitable, and after putting in a lot of hard work on the front end, you may be able to generate some passive income at some point in the future. But this is far from a guarantee, and it takes a great deal of luck and skill to achieve this result.

What is real estate investing? Not It is a fast, reliable, easy and guaranteed way to earn a great return on your initial purchase.

Unless you are very passionate about investing in real estate and want to dedicate time, energy and money to such a huge project, it is best to build your assets through other methods. Otherwise, it’s all too easy to find yourself working hard to break even at best.

With all the big financial undertakings, it’s best to be fully informed. The trade-offs might be worth your while. That’s cool – as long as those swaps fit into your big picture. Either way, when you know the fact that real estate investing is rarely passive, you’ll at least know what to get into.