Ask Brian – Real Estate Expert’s Weekly Column Brian Kline… If you have questions about investing in real estate, do it yourself, buying / selling a home or other housing related questions, please send your questions to firstname.lastname@example.org …
Question from Chelsea in Philadelphia: Hi Brian. I am a busy 34 year old professional who bought my first home at 28. My career is going well, and I have made an offer for a more beautiful house, in which I think I will live for many more years. I count my blessings because I don’t have to sell my first home to get into a new home. I already have a fully funded 401k invested in mutual funds. I am a busy person, but I am seriously considering diversifying my real estate investment by renting out my first home. My knowledge of real estate investing does not go beyond buying these two homes for personal use. Another option I thought of was selling my first home and opening a stock account outside of my 401k. I know how lucky I am to be in this position. But is real estate better than stocks?
Answer: Hi Chelsea. Congratulations on your success. My first thought is that the right questions probably helped you achieve what you are currently doing. Sometimes I address your way of thinking like this: “I don’t know what I don’t know, but I want to find the answers.”
Any investment requires work. There is a trade-off between investing in stocks and bonds or investing in real estate. Ultimately, it probably depends on how much time and effort you want to put into any of them. I believe that most real estate investments are safer than stocks and (importantly) you have a lot more control over the property. On the other hand, stocks have certain advantages such as having a lot of data at your fingertips and not needing a lot of capital to quickly enter and exit investment scenarios (liquidity). Real estate is nowhere near as liquid as stocks, but not nearly as volatile. With regard to stocks, despite all the data, you have almost no control over the effectiveness of specific investments.
Many investors try to compare real estate to stocks by comparing performance over several years. Something like comparing the 10-year rise in the S&P 500 to the increase in the average cost of single-family homes. This is a big problem because real estate is a very local investment. The fact that the average average home value in the US has risen by 12% does not mean that the same has happened in your hometown. In the correct city, the value of houses could increase by 18%, but in a less fortunate city, the value could decrease by 5% (figures may vary). The same can happen if you buy individual stocks rather than mutual funds. The value of individual stocks may decline while the average market price rises. Therefore, be very careful when making individual investment decisions based on averages.
Chelsea, with that said, looks like converting your first home to rent could be another great opportunity for you. Once your capital investment has been made, your main goal is to generate enough income to pay off your mortgage balance using other people’s money. This means that your home will be rented out (minimum vacancies) for an amount in dollars that covers all your expenses and has a positive cash flow (ROI). Unlike a mutual fund or stock of an individual company, you are the sole manager of your real estate investments. You must be financially prepared for things like emergency repairs, special HOA evaluations or fee increases (if applicable), and mortgage and utility coverage if you have a job. Along the way, you can upgrade your home to increase your monthly rent or keep it competitive in the local market. When it comes time to sell a rented property, it is not unusual for a major renovation to be needed. You will also likely pay a 6% listing fee to sell it. The bottom line is that you are in control and you need to do long term planning to maximize your ROI. This includes the opportunity cost of storing cash reserves that could otherwise be invested elsewhere.
Eventually, you will have tenants paying the mortgage and expenses for a house that you will one day get for free. But it doesn’t come without effort and risk on your part. With just one rental, you are probably going to manage it yourself. This can mean things like the tenant’s response to a blockage in the water supply at the most inopportune moment. And since real estate is local, it carries local risks. Being a homeowner has proven to be such a lucrative business that large institutional investors are very active in the market. Even if your rent is in the ideal market, something could happen, such as a large luxury apartment project being built a few blocks away, resulting in lower rents for single-family homes. Another risk is the closure of a large employer, which can lead to vacancies.
Chelsea, you are a busy professional and your time is worth the money. From the little I know; I think you will do well in real estate investing and renting out your first home is a great place to start. But it will take more time and effort on your part than investing in stocks. This is another opportunity cost that you want to include in the equation. A lot of money can be made as a real estate investor, but along with your career, it may not leave you with a lot of free time.
What do you think about investing in real estate and in stocks? Please add your comments.
In our weekly Ask Brian column, readers of any residential real estate experience invite you to questions. Please send your questions or inquiries to email@example.com…
Author biography: Brian Kline has been investing in real estate for over 35 years and has been writing about investing in real estate for 12 years. He also has over 30 years of business experience, including 12 years as a manager at the Boeing Aircraft Company. Brian currently lives at Cushman Lake, Washington. A place to stay, close to the country and the Pacific Ocean.