In the vast landscape of investment opportunities, real estate has long been a beacon of reliability and profitability. It’s a tangible asset that offers a steady stream of income, potential for capital appreciation, and opportunities for leveraging. However, like any investment, it comes with its unique set of challenges and risks. So, is real estate a good investment?
To answer this question, we delve into the pros and cons of real estate investment, using the hypothetical journey of Susie, a 30-year-old mother of three and elementary school teacher, who embarked on her real estate investment journey in 2010. This article presents past market data applied to Susie’s scenario, providing a comprehensive evaluation of whether real estate is a good investment.
Understanding Real Estate Investments
Real estate investing involves the purchase, ownership, management, rental, and/or sale of real estate for profit. It’s a broad field with numerous strategies, from direct property purchase to hands off fractional ownership through Real Estate Investment Trusts (REITs).
Direct property purchase involves buying a property, such as a residential house or commercial building, with the intention of earning income through rental or selling at a higher price in the future. On the other hand, REITs allow investors to invest in portfolios of real estate assets without having to buy or manage the properties themselves.
Investing in real estate can be a lucrative venture, but it requires a significant amount of capital, time, and knowledge. It’s not just about buying a property and waiting for its value to increase. It involves understanding market trends, property valuation, rental income potential, and the costs associated with property management and maintenance.
Example
In 2010, 30-year-old small town Susie, with minimal investing knowledge and limited capital, set a goal to own a rental property within five years. She calculated a need for a $40,000 down payment – a lofty aspiration given her modest teacher’s salary. This meant she had to save approximately $670 a month.
As Susie started saving, she sought reliable investment advice by opening an account with a local broker dealer branch Fidelity Investments, where they examined Susie’s financial situation. On a monthly salary of $4,000, Susie was left with $500 after subtracting her $3,500 expenses, which included her mortgage, food, and other necessities.
To enhance her savings, Susie took on tutoring jobs during evenings, adding an extra $200 to her monthly income. Additionally, she reduced her expenses by cooking more frequently at home, which saved her about $100 per month. These changes boosted her cash flow to $800. Of this, she invested $400 each month and allocated the remaining $400 to a rainy-day fund.
Building Wealth: REITs vs. Index Funds vs. Cash
Considering Susie’s budget and her 5-year goal, her broker-dealer presented her with several options:
Option 1: Diversify with Schwab U.S. REIT ETF (SCHH) & Vanguard Real Estate Index Fund (VNQ)
Both SCHH and VNQ are Real Estate Investment Trusts, which are investment vehicles that allow investors like Susie to gain exposure to the real estate market without having to directly own and manage the properties.
In 2010, if Susie had allocated $200 per month to each of these funds for 5-years, her investment in SCHH would reach $15,190, resulting in a gain of $3,190 (26.59%), and VNQ would have reach $17,525, yielding a gain of $5,525 (46%). Combining the two, her total investment value would be $32,715.
Option 2: Fidelity 500 Index Fund (FXAIX)
The Fidelity 500 Index Fund (FXAIX) is a broad market index fund which represents the 500 largest publicly traded companies in the United States.
In 2010, if Susie invested $400 per month into this fund, after five years, her investment would have generate a substantial gain of $7,623 (31.76%), resulting in a total value of $31,623.
Option 3: Cash Option
Alternatively, Susie could choose to keep her $400 per month in cash. Had Susie this option, her savings would have amounted to $24,000 after five years. However, accounting for a 2.5% inflation rate, the value of her savings would have diminished to $20,350.
Although Index Funds, Mutual Funds, and ETFs offer appealing risk-adjusted investment opportunities, Susie has decided to pursue Option 1 and invest in REITs. This choice is influenced by the potential for higher returns and the opportunity to invest in real estate without the need for direct property management.
Choosing a Real Estate Investment
When it comes to real estate investment, three key factors play a crucial role: location, price, and capital growth potential.
Location
The locality of a real estate investment property plays a material role in one’s decision making, as it affects the demand and rental income of the property. A property in a desirable location with good amenities, schools, and job opportunities will attract more potential tenants and buyers.
Price
Price is crucial as it determines the initial investment and potential return. It’s important to buy a property at a fair price or, ideally, under market value to increase the chances of capital appreciation.
Capital Growth Potential
Capital growth potential refers to the likelihood of the property increasing in value over time. This is influenced by factors such as economic growth, population growth, and infrastructure development in the area.
In 2015, Susie began studying potential real estate investments, eventually focusing on Raleigh, North Carolina. This city, with its robust economy, consistent population growth, and reasonably priced properties, presented an appealing real estate investment opportunity. She found a well-maintained, 3-bedroom house listed for $250,000 in North Hills. Her estimates revealed she could rent it out for about $1,500 per month, translating to a gross yield of 7.2%. Factoring in operating costs, she projected a net income of $1,000 per month, resulting in a 4.8% net yield. Confident in her calculations and the prospects for capital appreciation, she made her move, purchasing the property using her accumulated savings and investment returns for the down payment.
Risk Factors in Real Estate Investments
Like any investment, real estate comes with its own set of risks. These include market fluctuations, property damage, vacancy periods, and unexpected maintenance costs.
To illustrate, let’s consider that instead of buying her property in Raleigh, North Carolina, Susie chose to purchase a 3-bedroom property in Houston, Texas.
In 2017, Hurricane Harvey hit, displacing her tenants, and causing significant property damage. The costly and time-consuming repairs led to a year without rental income, and the local real estate market took a hit. By 2020, the value of the Houston property had only increased to about $275,000, providing a capital gain of $25,000. This was significantly less than the $70,000 capital gain she had made on the property in Raleigh.
By selecting a property in Raleigh, a region with a stable economy, consistent population growth, and a lower risk of natural disasters, Susie demonstrated her ability to mitigate potential risks. Additionally, she prudently maintained an emergency fund to address any unforeseen expenses that might arise during her investment journey.
Growth and Diversification
Fast forward to 2020, at the age of 40, Susie had accumulated a comfortable savings but desired to further grow her passive income while minimizing risk. To do so, Susie decided to join a real estate syndication team to invest in a multifamily development project in Nashville, Tennessee. The city exhibited promising signs of growth, including the attraction of new businesses, infrastructure improvements, and a steady influx of young professionals and families. These factors indicated that Nashville had a favorable outlook for the real estate market.
How did Susie fund this venture?
She had held onto her North Carolina property for ten years, over which the property appreciated significantly, generating steady rental income.
In addition, Susie had been re-investing her increased cash flow, diversifying into the (SCHH) & (VNQ) REITs and The 500 Index Fund (FXAIX), growing her investment to approximately $165,368. To become a 25% owner of the Nashville development project, she needed $250,000. Taking advantage of the 12.3% increase in home prices in 2020, Susie decided to refinance her North Carolina property, where she cashed out roughly $117,413. This strategic decision not only diversified her portfolio but also amplified her wealth growth potential.
The Long-Term Benefits of Investing In Real Estate
Projected to 2030, when Susie turns 50, she still intends to own both the North Carolina and Nashville properties. Assuming her North Carolina property’s rent has increased to $1,500 per month and its value has appreciated to $530,665, it represents a solid income stream. Meanwhile, her 25% stake in the successful Nashville property, which is now worth around $670,000, brings her an additional $2,000 in monthly rental income.
Combined with her teaching salary, now at $6,000 per month, Susie’s total monthly income stands at $9,500. Her net asset value, calculated from the sum of her property equities and other investments, amounts to approximately $1,200,665.
This journey in real estate investment has not only provided Susie with a significant income stream but also built considerable wealth. As she looks toward retirement, she can do so with financial security and peace of mind.
Is Real Estate a Good Investment?
Real estate investment, as illustrated by Susie’s journey, can be a powerful tool for wealth creation. It offers potential for capital appreciation, steady income through rentals, and opportunities for leveraging and diversification. However, it also comes with risks, such as market fluctuations, property damage, and unexpected costs.
So, is real estate a good investment? The answer depends on individual circumstances, financial goals, risk tolerance, and market knowledge. It’s crucial to conduct thorough research, understand the market, and make informed decisions.
Learning From The Past
Susie’s journey offers valuable lessons for potential real estate investors. First, it emphasizes the importance of financial planning and discipline. Second, it highlights the need for thorough research and understanding of the real estate market. Third, it illustrates the potential benefits of diversification and leveraging in real estate investment. Lastly, it underscores the importance of risk management.
Whether you’re a seasoned investor or a beginner, these lessons can guide you on your own investment journey. Remember, every investment decision should be based on careful consideration and sound financial planning.
