November 24, 2015
An early question many people have if they’re getting serious about actively investing in real estate is whether to get a real estate license or not. After all, if you’re out there buying and selling homes, it can be great to save the commissions and increase your income on every deal. Especially with fix and flip, there can be some decent savings if you can avoid using real estate agent commissions.
Many Deals Avoid Agents Anyway
If you’re marketing to attract distressed sellers, or if you’re using a lease-purchase strategy, you’re usually dealing directly with the seller anyway, so there is no real estate agent involved. If you’re flipping to another investor, the same thing applies. If you’re buying and fixing to hold for rental property, you may end up with commissions if it’s a listed foreclosure, but they’re generally lower because the lender selling the home negotiated it that way.
So, unless you’re doing a lot of deals with real estate agents involved on one or both ends, you’re generally not going to see a major savings or income boost if you get your license. An exception could be if you are using an investor or investor group and guaranteeing them a specific return on deals. If you are, and your commission as the agent is a valid cost in the deal, it could be extra income for you.
There’s Time and Money in Maintaining a License
Real estate laws vary by state. But, in almost every state, the licensing laws require upfront license fees and periodic renewals, often in the hundreds of dollars. You’ll have local MLS, Multiple Listing Service, dues to access the listings. Many of these associations require membership in the National Association of Realtors, another annual fee. One broker added up just the licensing and MLS fees and found that his costs were around $ 1,500 per year.
Many states also require bonding and or insurance to practice. The same broker had an annual premium of around $ 350 for required insurance, and it couldn’t be shopped much, as the state mandated that only companies were to be used. Now, if you aren’t doing any active real estate other than for yourself, that’s probably all you’ll have out of pocket. However, in most states you must work under the supervision of a broker, and they will not want to take on a part-timer without some compensation. This can be a percentage of each commission or monthly desk fees.
Now let’s talk about the annual Continuing Education requirements. These vary, but usually require around 30 mandatory renewal hours in classes mandated by the state. So, you have the costs for those as well. These may be annual or for a two or three-year license period. So, just to maintain an active real estate license, you will have significant out-of-pocket costs.
In most states you can do your own deals and not be forced to hire a real estate agent. You’re considered to be in charge of your affairs and the risk is yours. However, once you have that license, things change. Your dealings with that seller and buyer will be considered as giving you an advantage with your license training. You pick up some liability in the transaction if anything goes wrong. You are subject to complaints with the state and even lawsuits in extreme cases.
Well, I’m done selling you on getting a license! Actually, in some cases it can be an advantage, but in the majority of investor deals, even fix and flip, it’s usually not going to yield enough to be worth the added cost, invested time and risk.
November 14, 2015
The image is of the Craigslist search results for a search in the Real Estate Wanted category on the phrase “want lease to own.” Some of these are likely investors, but others are individuals who want to ultimately own a home, but for various reasons they need to lease it right now.
There are other ways you can locate opportunities for lease to-own-homes, from the classifieds to Web searches and even on the social sites. Are you in a situation that keeps you from buying right now, but you are stable in the area and wanting to own at some point?
- Saving up for a down payment.
- Repairing credit history.
- Expecting higher income in the future, want a larger home than you can buy now.
There could be other reasons unique to you, but the point is that you want to own a home in your local area, but you’re not ready to pull the trigger on a mortgage right now. For many people, they are fine with paying a little over market rent for the right home if they can get the option to buy it after a specified period of time. The idea is to get a feeling of permanence, not feel like a renter.
Another advantage is that you can begin to do minor modifications and renovations if you want in order to make this your home. Of course, you aren’t going to take these improvements with you if you leave, so don’t get carried away unless you’re really sure you are going to exercise your purchase option.
Sometimes you can make an agreement with the current owner for certain improvements the property needs and that will improve its value as well. There can be a rent tradeoff, so you aren’t footing the entire cost. The owner’s motivation to agree is that the home will be worth more if you’re taking good care of it and making value-enhancing improvements. So, if you leave without exercising your purchase option, they have a property worth more in the market.
So, how does lease-purchase (rent-to-own) work?
A homeowner wants to sell, but for some reason can’t at the time. Perhaps they just need to move in a hurry for a job, and they can’t afford to keep the home and rent in their new area both. Renting it out is a temporary solution, but they still have to sell it when they can. And, they worry about the condition of the home with tenants in it and them living far away and unable to check the home from time to time.
Whatever the reason, there are owners out there who would be willing to rent you their home with an option to buy. Let’s be clear that it is an “option,” not a requirement. You do not have to buy it. The lease could for example be structured for three years at a set amount for rent that will cover the mortgage and escrows for taxes and insurance. It will state a price at which you can buy the home on or before the expiration of the lease.
The agreed upon price can be a hard number, or it can be the value from an appraisal company that is independent and acceptable to both of you. If you expect home values to rise, setting the price at the current value is best for you, the tenant-buyer. The amount of the rent is negotiable, and it can be more than the mortgage and escrow, and can even include a monthly amount to go toward the down payment.
This is a simplified example, so you’ll want to do your research and get an attorney to review the lease-purchase agreement. You can move into your new home today and buy it later.
November 8, 2015
This article is for the investor who wants to move into real estate, but they want a higher level of involvement than just buying shares in a REIT, Real Estate Investment Trust. You still do not want to buy and sell properties or work with contractors, but you would like to get a nice return on investment in a real estate investment environment. You also want short term turnover of your money to limit market risk.
Let’s say that you’re currently invested in stocks or bonds and your pre-tax return in in the low single digits. This isn’t that bad considering the current interest rate environment, but after even nominal inflation, it really isn’t exciting at all. You’d love to up that return by a few percent, and you would do a dance for double digits with acceptable risk.
The problem is that there aren’t really any formal mechanisms in place to connect someone like you with a fix & flip investor or wholesaler who is knowledgeable in real estate and in need of funding. This lack of an established communication connection makes it tougher for those deserving of your funding from connecting with you and happily giving you the returns you want.
The best place in most local communities where an individual passive investor can connect directly with active wholesalers and fix & flip investors is in a real estate investment club. The thing to remember in the club situation is that there will be investors with varying levels of experience and success; or lack of it. This just means that you’ll need to know your business and do your due diligence.
What is Level 2 Passive Investing?
So, you don’t want to just buy REIT shares. You want to invest directly into properties in your area by partnering with active investors. You still want to be passive, just providing funding for their projects. We’re not talking about long term rental investing in this case. We are interested in providing short term funding for fix & flip and wholesale investors.
The wholesale investor usually does no rehab on a home. They specialize in locating deep discount properties and flipping them to other investors. Those could be rental investors if the property is ready to rent, but more often they go to rehab or fix & flip investors.
The fix & flip investor is going to do repairs or major renovation to bring a home to livable condition. They then sell it to a rental property investor or sell it on the open market to a retail buyer.
Our passive role is to provide the money they need, which could be a time requirement of just days to months. A wholesale deal can even close both ends on the same day. So, as the money person, you can put funds to work for hours, days or weeks and get returns well above other traditional investments.
How Does it Work?
When you connect with one of these active investors, you really need to check their track record. If you want to take a gamble on a newer wholesaler or fix and flip investor, definitely do your research on the property, their buyer, and the time your money will be at risk. They should have a buyer or potential buyers lined up before you put up money to buy a property unless they’re selling in the retail market. It is easier to work with investors selling to other investors, as they often have a standing relationship and offers to buy properties that meet their requirements.
Before you dish out money, you take out a note or lien against the property to cover your investment, and generally keep your involvement to 60% or less of the current value of the home. This gives you some room to sell it and get your money back if something goes wrong.
You charge whatever fees and interest charges you want within reason. They have to make a profit too you know. Professional transaction funding companies charge loan initiation fees, double digit interest rates on loans that are out for more than a day or so, and they also charge other fees. You should be able to achieve double digit returns on your invested money. Check transaction funding websites to see how they set their charges.
Do your homework to limit your risk, and you can turn your money over multiple times each year for some amazing ROI numbers.
October 29, 2015
You don’t have to be the investor in the photo. Sure, doing anything for the first time can be a little stressful. And, it’s definitely a major investment to buy your first rental home. But, you really can make it happen without going into stress overload. Here are my top 5 tips to enjoy a successful and low stress first rental property investment.
Tip #1: Advice is OK, but Do Your Own Research
Take courses, read investment books, go to a seminar, or any other learning process that helps you to gain confidence to make decisions. I suggest that any books, courses or seminars be about how to select locations, value properties and evaluate the rental market. Your success will be based on your due diligence and most of all buying right in the right area.
Your first rental property investment is best done in your area of residence, where you know what’s going on economically. You want to know that the economy will support today’s decision into the future, as this isn’t a short term strategy. Understand who the major employers are, what drives people to move in or move away, and if things look good into the near future.
Tip #2: Don’t Just Rely on Real Estate Agents
Sure, now and then you can work with a real estate agent who handles foreclosures and get a good deal. Remember though that these will be “listed” foreclosures on the MLS, Multiple Listing Service. You and all of your competitor investors have access to the same information, so competition will likely drive up your cost of acquisition.
If you do your own marketing and locate motivated sellers, you have a greater chance of negotiation a good deal. Another approach is to work with an experienced real estate wholesaler. They are investors too, but they are experts and finding great deals that they can flip to rental property buyers at a below-market value price. Just check their references out and be sure they do know what they’re doing.
Tip #3: Know What Will Rent and for How Much
Check with property managers who handle single family homes. Go to the classifieds and check out what homes similar to the one you’re considering are renting for. Are the owners offering incentives like free months? This is usually a sign of a soft rental market or heavy competition, so you may want to try another neighborhood or property type.
Call on ads, drive around, talk to landlords as if you’re a tenant. The most important thing for you to know before the next tip is what you can reasonably and conservatively expect for rental income and low vacancy.
Tip #4: Get the Right Financing & Cash Flow
You need to know all of your costs, including estimating repairs and other maintenance costs. But, the mortgage is going to be your largest cash outlay, so it is your most important cost consideration. You’ll need to put 20% down or more in most cases. For a rental unit you may also pay a slightly higher mortgage interest rate. A great credit history helps in this regard.
Get a firm handle on all of your costs, then see what your mortgage payment with taxes and insurance escrowed will be. Let’s use an example of a $ 150,000 home with a $ 32,500 down payment and closing costs. If you can manage to clear even $ 250/month over cash out of pocket, your return on the actual cash invested is going to be around 9%.
Tip #5: Lock in Equity at the Closing Table
NEVER buy at retail market value. If you can’t get the home at a 10-20% discount to its current market value, don’t do the deal. You want to leave the closing table with that equity as either future profit or a cushion should you have to sell before your initially planned liquidation date.
If you’re going to work with a wholesaler who you may meet at a local investment club, be clear that you’ll want to see their valuation calcs and you’ll check them with your own. You give them your requirement. If it’s 15% below market value, then they will know what they have to deliver.
You’re in control here, and you don’t have to make a deal until you know it’s going to be a great investment.
October 21, 2015
Go to Google and search on “free lease agreement template,” and you’ll get thousands of results. It’s not hard at all to find a lease you can download and use for free. What is much harder is making sure first that all of the terms in it are legal in your state, and also that you’ve covered your interests adequately as a landlord.
Let’s look at a dozen things you may or may not find in a free lease template, but make sure that you handle them according to your state’s laws.
1. Rules violations that result in fees or penalty costs and how much: you don’t want to try to fine a tenant or withhold money from a deposit for violating some rule unless you have their signature on a lease that clearly tells them what the rules and fines are.
2. Require renters insurance: this is really cheap insurance that covers the belongings of the tenant. Should, and you hope not, a fire or other catastrophe cause tenant possessions to be damaged or destroyed, you want them covered so they’re not claiming against your insurance.
3. Included appliances: this may seem overkill, but you don’t want to find something like a garbage disposal missing when it doesn’t show up as being a part of the unit in the first place. Also, it’s even better if you have unit model and serial numbers by unit, as it has happened that nice appliances were swapped out for not so nice items. You would think that this is something you’d notice on a walk-through, but when you own lots of units, similar looking appliances much older or of lesser value have been known to be swapped into the unit.
4. When and why you can enter the unit: this is going to be somewhat controlled by state landlord/tenant laws. In most states you’re required to give written notice, usually 24 or 48 hours, unless you suspect damage or an emergency situation. This is one you need to be very clear about, and you need to get into units every so often to make sure they’re not being damaged in major ways. A good approach is to say that you’ll be making a scheduled visit to change batteries in smoke detectors every 4 months or something like that. They’ll not complain if you’re keeping them safe.
5. Furnace and air conditioning filter replacement: this is another case of probably needing to enter the unit. You can require that tenants change the filters if you provide them, but you can’t be sure they are doing it properly or at all. You’re far better off to do this with staff.
6. Costs and terms if lease is broken: sometimes even good tenants can have a job problem or other valid reason for needing to move. In fact, if they lose their job, you would probably rather let them out of the lease instead of having to evict them for non-payment of rent months later. Clearly state the penalties for breaking the lease and have them initial next to this section.
7. Home Office rules: more and more people are freelancing or working from home every day due to technology and the Internet. You don’t want to tell them they can’t, but you need to set the rules for whether they can have customers/clients visiting or not, and where they can park if they do; as well as limit that activity.
8. Pet rules and fees: allowing pets will generally result in lower vacancy rates, but you need clear rules as to size, type, unwanted breeds (dogs), where they can be walked, cleaning up after them, etc. People dote on their pets, but you must make sure they’re not treating them better than the landlord!
9. Abandonment and possessions: yes, sometimes a tenant will just disappear and never return, leaving personal items in the unit. Sometimes they just didn’t want them anymore and are using you as their disposal person. However, your lease needs to be clear as to how long a unit can be unoccupied before you will consider it abandoned and personal belongings sold or donated.
10. Damages vs “wear and tear:” really be clear and detailed about this, as you’ll be withholding deposit money to repair “damages,” while normal wear and tear is considered just that; normal. Then create a detailed walk-through checklist with a move-in and a move-out check column. Do a careful walk-through with the tenant at move-in, take photos and get them to check satisfactory condition. Do it again on move-out and note and document damages with photos.
There are other items you may want or need in a lease, and some will be location specific, such as snow removal, etc. Get your lease blessed by an attorney for the best protection of your interests.
October 2, 2015
The new FHFA, Federal Housing Finance Agency, House Price Index has been published with data through the end of July, 2015. Here’s a chart to get the discussion going:
Notice that house prices are approaching the highs from 2006. We should be having parties, tailgate barbecues, rejoicing! We’re not, simply because this is a number derived from repeat sales of homes, so let’s analyze that a little.
The FHFA House Price Index tracks the resales of homes, from one price to the next resale price. Now, this is an accurate indicator of price movement if the home hasn’t been materially changed since the previous sale. So, why is this high level not telling us that things are great?
First, and most important, it requires repeat sales of homes, so if there aren’t huge numbers of sales, then we’re looking at a number derived from a small set of sales data. So, we’re not necessarily seeing an excited bunch of buyers flocking to the market. We are seeing a whole lot of homeowners who aren’t selling, waiting for rising values. So, we have a small inventory and competition for it. If all of the homeowners on the sidelines listed their homes tomorrow, we’d see a major difference.
Now let’s contrast some recent Zillow home sales price data. There are plenty of critics of the accuracy of Zillow data, but there is some value in it. A recent study at Zillow tells us that one in four homes are worth less today than a year ago. It’s really hard to see one data set saying prices are rising to high historic levels, and another telling us that a major chunk of homes are worth less this year than last.
We’re seeing around a third of major urban markets experiencing competition and significant price gains. However, the rest of the country is definitely not seeing a flood of buyers fighting over even a low inventory of listings.
Of course, you’ll hear from the National Association of Realtors that Zillow’s data is faulty, and I do agree that you have to take it with a grain of salt. However, if homes are worth so much more now than two years ago, would we not see a flood of listings from fence-sitting owners who want to cash in and move up or move away?
Real Estate is Local
We’re back to the “real estate is local” meme, and it’s still around because it’s very true. Your local market is going to have its very own unique economic and home price influences. You can’t take national news and surveys and just apply them locally.
If you’re a homeowner who has considered selling but held off due to market conditions, it probably is a good time to check out your home’s value. Listing before the rest of the world figures out things are better will get you a better sell price.
Don’t call an appraiser, as their approach to market value is different than that of a real estate professional. The real estate agent is trying to get you a sold price near to the top of the market, and their CMA, Comparative Market Analysis, is going to give you a pretty good idea of its value.
But, get a CMA from two or three agents from different brokerages. Their process requires choosing recently sold comparable properties, and their selection process can change the outcome significantly.
September 24, 2015
You’re getting excited about buying a home, and you’re seeing some really great properties in desirable subdivisions and neighborhoods. Driving through a neighborhood, you see well-manicured lawns, no junk in the yards, and just a general upscale appearance.
That’s in large part often due to HOA, Home Owner Association, covenants and restrictions. I’m not knocking the concept, nor many of the most popular restrictions in place around the country. Maintaining everyone’s home value by keeping neighborhoods looking good is important.
However, too many buyers do not take the time to actually read the sometimes really thick HOA documents presented to them during the transaction process. Few real estate agents are going to try to sit them down and make them read them either.
The fact is that a restriction on your use of your home or lot can be perfectly suitable to one owner and very onerous to another. You and your family are the ones who will live in the home and in most cases you’ll be fine with what you cannot do or have according to covenants and restrictions. The key is to know before you buy.
Let’s use a couple of examples that are actually pretty common. I’m not saying that they will make you want to move, but they can make life inconvenient.
Boats – Boat Trailers
In a great many areas, you cannot have a boat trailer, with or without a boat on it, sitting in your driveway. If you envisioned your double-wide driveway accommodating your second car (one in the garage) and your boat on a trailer with a cover, that won’t be happening. You’ll come home to find a note on your door from the HOA.
Sure, you can put both cars outside and the boat in the garage, but that $ 5,000 boat is enjoying the protection you had envisioned for your $ 50,000 SUV. The vast majority of the residents of the subdivision are fine with this, as they don’t think the neighborhood looks nearly as good with boats in front yards. You on the other hand, may have looked elsewhere if you’d just read that HOA restrictions document.
Outdoor Storage Building
Maybe you did give the restrictions a quick overview, and you didn’t see anything about not being able to have a storage building in the back yard. You have hobbies and must store a lot of stuff that won’t work in the garage. So, you get your Home Depot 10 x 10 building and you’re in business … wrong.
What you missed was the restriction against anything in a yard that peaked above the height of the wooden privacy fences, all mandated to be no higher than six feet. Now, instead of a storage building in which you can stand erect, you’re erecting something more like a big doghouse for your stuff.
No Big Deal – Unless It Is
Neither of these examples may mean anything to you, nor may any other of the sometimes hundreds of pages of covenants and restrictions. But, you won’t know until you read them. Do not ignore any document presented to you as a disclosure in the transaction process, as it can be really annoying or worse later.
September 18, 2015
There can be emotions involved when you’re selling your home. Emotions can get intense if you also find that the buyers are doing some hardnosed negotiating. If you want to get out in front of some of the tough negotiating, think about using throwaway contingencies right from the start.
What are contingencies in a real estate deal? There are always contingencies, many mandated by the process itself. You’ll have a financing contingency, inspection and repairs contingencies, and even deals contingent on your approval of surveys and other documents. These are normal requirements to protect both parties and get through a successful closing. However, there are other contingencies specific to the property or the buyers and sellers.
When you’re listing the home for sale, your listing agent will ask a lot of questions, many of them necessary to properly present the property in the Multiple Listing Service. They want to be sure that the property is listed with all features properly categorized, especially as to whether certain items are to be included in the sale or not. Generally, anything built-in, such as built-in bookshelves and all items permanently affixed like light fixtures are expected to be included. There will likely be specific contract language addressing what is and what is not to go with the sale.
What we want to talk about here are items or contingencies that you may not even be thinking about, or that you simply don’t care that much about. You shouldn’t consider them as unimportant to the buyer just because they aren’t important to you. Let’s look at some examples.
A free-standing wine refrigerator - You would normally just be thinking of taking it with you, but you should specifically rule it out as going with the sale so the buyer sees that when they make their offer. If you don’t feel strongly about it however, then you have a negotiating point that you can trade for concessions in price on their part.
A free-standing hot tub - In many cases the homeowner will list this as staying with the home to make it a selling plus. They don’t want to take it with them anyway. However, you may want to list it as excluded in order to make it a “giveaway” trade item to offset demands of the buyer or to get their offer price up.
The backyard storage building - That self-assembled metal storage building that you really intended to leave could also be excluded as a throwaway contingency item. You can give it up to get buyer concessions even though you never really intended to disassemble it anyway.
High end patio furniture - Some sellers want to take their deck and patio furniture with them, but they aren’t totally in love with it. Generally these items will not be mentioned in the contract as it is furnishings and expected to go with the seller. However, you can use it as a giveaway if you hear that the buyers like it or they have none of their own.
This strategy isn’t for every deal. An example: if every home for sale in the neighborhood is including the hot tub, excluding yours in the listing could hurt showings. Balance the competitive environment with your negotiation tactics.
Remember that the entire process from the signing of the initial contract through inspections and document reviews is still a negotiation. Even if you don’t use a throwaway contingency in the original price negotiation, it could come in handy in negotiations over repairs of items in the inspection report.
September 12, 2015
There’s no shortage of news about Uber and how it is connecting riders with drivers and cutting out the taxi companies. Some cities are fighting the trend and legislating them out of the area, and others are still trying to figure out how this service has become so popular so quickly. This isn’t about that, but it is about connecting buyers and sellers directly and increasing the value for both in the process.
I’m thinking that there is an opportunity for retail consumer home buyers to work directly with real estate fix & flip investors to get a great deal on a home and create more profit for the investor than they may be getting now.
The Wholesale Fix & Flip
I call it wholesale because many fix & flip investors are buying a property in need of rehabilitation and selling it to a rental property investor when it’s a rentable property. The reality of this situation is that both parties involved are investors. The rental property buyer, at least if they’re good at what they do, wants to buy the home at a significant discount to current retail market value.
The fix & flip investor does a lot of due diligence, research and marketing to locate properties with motivated sellers. The goal is to get a deep discount buy on a home needing work, perhaps a foreclosure, rehab it, and sell it to a rental home investor. The rental home investor is a pro, so they want to pay less than it’s actually worth in the current market. Usually they’re looking for a 10% to 20% discount.
Of course this challenges the fix & flip investor, but that’s why they make their profits. They are skilled at locating the very best distressed properties for purchase and making their profits on the rehab. They can still sell at a market discount to the rental property buyer.
There has been a definite shift in this market recently, primarily due to the drop in foreclosures and rising prices at which the fix & flip investors have to purchase. It makes it more challenging to make a decent profit to justify their risk and efforts. More fix & flip investors are selling to regular consumer buyers in the retail market.
There are other challenges in this market. One is that marketing costs are higher, and definitely costs of sales rise with real estate commissions. It’s a necessary cost of doing business, but it does discourage some investors from working in the retail sector. The costs of holding the property increase the longer it takes to sell. Generally, on the wholesale side the sale is closed quickly with a buyer who the investor has already solicited for the property. When it’s going retail, marketing must turn up a buyer.
Fix & Flip investors should be taking an Uber approach.
Suppose fix & flip investors do more general marketing with the goal of letting retail buyers know that they are in the business of selling to them, and that the investor has mortgage contacts to help them to finance their new home. Advantages include:
• Higher profits on the flip.
• Buyers can reach out to investors earlier and possibly even specify some finishes and amenities, just as they can with a new home builder.
• Buyers can possibly get a small discount to full retail value, even with the investor getting a better-than-wholesale profit on the deal.
It’s just an idea, but it seems to be logical and a way to create a win-win situation for investors and buyers.
September 10, 2015
Before my added “Ya Think” emphasis, the title is the same as a title of an article this week over at Money,USNews.com. It’s not surprising to see an article like this now, as the China situation took the Dow Jones down in a dramatic way over the course of a week or so. If you want some historical perspective, there are some dates and Dow plunges historically:
• August 24, 2015: -588.47
• August 21, 2015: -530.94
• August 8, 2011: -634.76
• Six more 600 points or larger drops since 2000.
Yes, if you just bought and held for 15 years, you would have done well in stocks. Unfortunately, many people can’t simply drop a major chunk of change into stocks and just let it ride for that long. And, depending on when you buy, having to sell after a drop like these can be devastating to your savings and retirement.
So, that said, I’m not saying dump all of your stocks and buy real estate … particularly not now. However, the next time your stock broker advises you to “diversify,” don’t just do it with stocks. Let’s look at some of the points referenced in the linked article.
Actually, the article wasn’t really that positive about the advantages of investing in real estate. Things like the ease of placing stock trades and low cost of transactions were mentioned. Property taxes were mentioned as a negative, and they are to a point. The article’s title really wasn’t in my opinion supported very strongly by the content. So, let’s take a look at some differences between stocks and real estate as an investment asset class.
Stocks are susceptible to inflation risk. Your return is whatever it is, including dividends. When inflation gets rowdy, it can take away major chunks of your investment gains in stocks. That’s not to say that real estate is inflation proof, but there are some logical reasons why it may be better.
Let’s think about what inflation really is. It is an increase in the cost of goods and services. So, what do you expect to happen to home prices when wood, tile, wiring, plumbing and other materials and labor costs increase? If it costs more to build, usually within a reasonable period of time it will cost more to buy. Your owned property value can actually increase during inflationary periods.
Interest Rate Increases
When interest rates rise, stocks and definitely bonds usually suffer. It costs companies more to borrow to expand and finance operations, so their profits are reduced. Bonds carry a fixed rate of return, so their value drops when interest rates increase.
If you own rental real estate with a fixed mortgage rate, interest rate increases don’t really bother you. In fact, they can help. If mortgage rates rise, more people must rent than buy. Rental demand increases and rents rise.
Sure, you must pay property taxes if you own real estate. However, if you’re doing your job, you factor those into your purchase of rental property and the positive cash flow you project to receive. Sure, they can go up, but you may be able to offset that with rent increases.
One major difference is in using the IRS 1031 Exchange rule for growing your real estate portfolio. While the stock market investor will pay capital gains taxes in the year they sell a stock at a profit, real estate investors get a major break. Using this IRS rule, you can sell and roll the profits into another investment and forego paying capital gains. It’s complicated and the rules are strict, so an accountant needs to be involved.
I’m not trying to push anyone into real estate who is afraid of it or not suited for a landlord’s duties. But, there definitely are reasons for real estate as a diversification strategy.