START INVESTING | Real Estate
What makes Real Estate Similar to Stock Trading – and What Not
Download the free Real Estate Evaluation Checklist!
Download the free Real Estate Evaluation Checklist!
Investing in real estate is a popular way to invest.
And it kind of makes sense. Spend your money on something tangible like an apartment or a house… either live in it yourself so you avoid spending money on rent, or rent it to someone else and BAM!
There is your regular passive income.
But is that how it works?
It’s more complicated than that.
Let’s have a closer look at what is needed to buy a property. There are various ways, I will look into these two:
- Existing Properties
- Off-plan Properties
An existing property can be either brand new or many years old.
It might need refurbishment or additional finishing, but the construction phase has been completed and it can be rented or used immediately.
An off-plan property is a property that only exists on paper.
You can buy it under better conditions, like an installment plan and at a slightly lower total price than existing properties. However, you need to wait until it has been built before you can use it.
Buying existing property
Here is how it goes:
- Do your research to find a property that fits your requirements
- If needed, find a mortgage
- Buy it
- If needed, fix it
- Rent it
Step #1: Do Research
Arguably the most important step. There are many things to consider when looking for the “right” property. If you look for a property that you like to rent out:
- Location: is it within the neighborhood you want?
- Price: can you afford it (with or without a mortgage)?
- Rent-Price ratio: will the rent be high enough to make it worth while?
- How fast can it be sold again, if needed?
- What fees do you need to pay to real estate agents, municipality, and government?
- What will be the running costs?
- Do you need to refurbish before renting?
- How fast can it be rented out?
- What are mortgage rates for this type of properties?
This is not an exhaustive list by any means… however it is a large amount of money so every additional research that can help improve your investment will help.
Step #2: Find a Mortgage
Finding a mortgage is a large subtopic just by itself…
As this is a financial commitment lasting for decades, doing a lot of research on finding the one matching you is essential.
I am no expert in mortgages but I will write more about them a bit later in this article. Just keep in mind that a 20-30 year obligation is a serious thing and justifies more than just a few hours of research.
One word about mortgage payments: ideally the rent should be higher than your mortgage payments, as it provides a financial safety cushion.
And… mortgage and rent rates keep changing over time!
Step #3: Buy it
Once you have the right property (and if needed, the right mortgage), follow through and do the purchase. You will need to pay the real estate agent and often also the government (for title deed etc.).
Step #4: Fix it
Even if the property is brand new, it will still need some maintenance before it can be rented. Take this into account when doing your “investor math”.
I once bought an apartment and it did not have a floor finishing. Yeah, right?
So I had to look for proper flooring, buy it, make appointments for getting it done (that alone was a 6-week waiting list), get it finally done (another week), clean up afterward etc.
This not only costs additional money but also the precious time that is not available for rental income.
Step #5: Rent it
Finally, rent it as soon as possible and be selective to whom you rent!
Depending on local law, a tenant who defaults on his payments might be able to stay for several months before you can make him move out… and you will not get paid during this period.
- Will the tenants pay me regularly, or could they default?
- Once the tenants move out, how might the property look like? Will it need a major refurbishment?
- Make sure the contract terms state clearly who has to pay for what repairs (which inevitably will be required sooner or later).
- Spend a good amount of time on the contract small print before signing the contract.
And that is it! Hopefully, after that, you can start enjoying your additional income.
Get my detailed Real Estate Investment Checklist to make sure you don’t forget any of the due diligence!
Buying off-plan property
The steps for buying a property “on paper” are similar. There are two major differences though.
- With the right installment plan, you might not need a mortgage, or only once hand-over is coming up.
- You will not have any rental income until the property is ready and was handed over to you
I signed up for an off-plan property deal once and I regretted it. Badly!
- The building developer had many delays (4-5 years until handover instead of the projected 2 years).
- The property market was down at handover time, so the market value of the property was below the purchase price (that sucked!).
- Mortgages were difficult to obtain and only at terrible rates (you might have guessed… it was the financial crisis!).
What is similar to stocks?
Well… not a lot. At least that’s what I think. But there are some similarities:
- It needs proper research and study before diving in
- If things go well, it provides a steady passive income
- You can apply leverage: borrow more money, own more properties, make more income, etc.
- There are market trends: prices fluctuate and you can buy during a time when prices are low and sell when they are high to make capital gains
There are other advantages compared to stocks:
- If rent pays for the mortgage and maintenance, it automatically pays for itself
- There might be tax advantages, depending on country or state laws
- It’s tangible. You can actually touch it 🙂
- You can use it for yourself or your family if needed
What I do not like about it
It’s a no-brainer… I got burnt before with “investing” in real estate, so I do not like it.
But to be fair, the main reason why I made a bad experience was that I did not do the proper research. And like with trading stocks, if you don’t know what you are doing, it will cost you (dearly!).
First, a quick look at what I mean by “investing”:
An investment is something that provides a financial return at a risk.
Now let’s look at this definition and see if it applies. Financial return means that an investment makes money for you.
Are you paying regular installments for years and years without making money? That’s not an investment.
Paying mortgage for 20 years and the rent is below your mortgage rate plus running costs? It’s not an investment. And if you think “well it’s my home so I do not pay rent”, then think again.
It’s NOT your home until you paid off that mortgage. It’s like paying rent to your bank, for decades. And if you default, the bank owns it. It might be your own dream home after you paid it off. But again, it’s not an investment.
I love Robert Kiyosaki’s definition of “assets” and “liabilities”. It’s straight to the point and can be applied to everything related to money:
An asset is something that puts money in my pocket.
A liability is something that takes money out of my pocket.
It’s simple and brilliant. If you did not do so yet, I strongly suggest you read his best selling book, “Rich Dad Poor Dad“.
I wish I had read this book 15 years earlier. My real estate debacle would never have happened and my second income would be considerably larger by now.
What about Risk?
That’s one of my key issues with real estate investment. Many people assume that the risk of investing in real estate is low.
It’s NOT. At least not for most people.
What does risk mean? Here’s what the dictionary definition says:
A probability or threat of damage, injury, liability, loss, or any other negative occurrence that is caused by external or internal vulnerabilities, and that may be avoided through preemptive action.
Not so helpful. Basically, it’s something bad. But how bad? It’s better to define it as something else:
Risk = Likelihood x Severity (of something bad happening)
It means that risk is something that has two parts. One part looks at how likely is it to happen. And the second part looks at how bad it is IF it actually happens.
The important part is severity: what is the financial loss to you? Imagine you put all your money into a $1,000,000 luxury apartment. You can barely cover the mortgage with your income.
Now the real estate market tanks and your apartment value is at $600,000. Your loss: $400,000. That’s crazy!
If you own 100 different properties, in various locations, and it happens to one of them… never mind. Your loss is only 0.4% of your capital. Nothing to worry about. But if all your money is in one basket… tough.
Is it likely to happen? Well, it happened in 2008 during the financial crisis. Nobody thought it would happen… and yet it did. And prices fell more than 40%.
I also hate the idea to pay for a mortgage for decades. But that’s just me.
My list is long, but I will summarize only briefly what are my primary issues with investing in real estate.
It might not be an issue for you. Just think about it before you take the plunge:
- Risk: I already mentioned it in detail above. Hard to control!
- Diversification: to diversify in real estate you need to be seriously rich. Once you are rich, go for it.
- Liquidity: It takes months to sell instead of minutes…
- Tangible: it’s not as tangible as you might think. Unless you paid it off in full already, it does not even belong to you.
- Obligations: making monthly payments to a bank for 20-30 years? No thanks.
- Fees: depending on location, you might pay 4-6% to your broker and the same to the government… that’s 10% down before you even started!
- Location dependent: you need to be there to understand the local market; if something goes wrong you need to deal with it (like fixing stuff). Or pay someone who you trust to do so.
- Running costs: with or without a tenant, there are always costs. Fees, taxes, maintenance, utilities, property manager etc.
To summarize, real estate investment has its place and it can work. But I believe for someone with a “normal” income, the risks are too high.
The exception is to have your own home. If that is what you strive for, by all means, go for it. Just don’t call it an investment (or an asset).
I feel safer with investing in stocks. But there are many different types of investing in stocks. In the next post, I will look into penny stocks and day trading.
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Download the Real Estate Checklist (PDF):
Click on the images or links below to get the file.
The checklist guides you through the following subjects:
- Financial goals
- Purchase process
- Property type and “ideal” tenant
- Finances and return on investment
- Initial costs and running costs
- Income projection
- Mortgage considerations