I used to invest in stocks like a lot of individual investors since it is so easy to buy and sell stocks. All you have to do is set up a brokerage account and start trading. Read some news, analyst reports and you can place orders with a few mouse clicks. Many people think they are pretty good with picking stocks when everything is going up. When the market sentiment goes the other way, they are usually not quick enough to exit their positions at the beginning and can’t resist to sell out of fear when the market actually bottoms. After years of stock investing, I come to realize that I don’t have much edge over other individual investors, let alone wall street gurus with access to all the insider information and insane amount of computing power. With stock investing, your performance often gets worse when you spend more time reading all the “fresh” news. When any of those news reaches your eyes, they are already stale and priced in. If it is somehow not priced in, that usually means there is something the insiders know and you don’t know. I started real estate investing a few years ago. The longer I do that, the more I wish I had started doing that many years sooner. If I started doing real estate investment as soon as I was out of school, I can probably retire comfortably. After building enough hands-on experience and doing my own due-diligence works by digging into the data, I realize that while it doesn’t apply to all people, real estate investment is the best channel for most individual investors with reasonable amount of capital. It’s the best way to grow your wealth with great appreciation rate and containable fluctuation, without being exploited by the wall street manipulators. I will list a few points that make real estate investment superior compared with other investment options.
One of the most important characteristics of real estate investments is its resilience. While most of us have heard scary stories about how the value of your house can plummet by 50% in the event of a housing crisis, in most cases, the lost value is usually recovered over time when people look past the fear in the bear market and start buying homes again. As long as you have a decent income flow to cover the mortgage payments and sit through worst times, you can easily get good returns outperforming the securities market. This is exactly why people are comfortable with huge invested capital and high leverage when it comes to real estate investment. If you are not forced to sell, you will prosper over time.
2. Good cash flow
Most real estate assets are income-producing properties, yielding 4%-6% cash every time if you buy them with cash. This important feature provides a great safety net and puts time on your side. On top of that, the housing price in America appreciates about 3.5% every year on a national average basis. You can comfortable get 8%-10% return in terms of long term average even if you invest all your money in cash.
3. Decent leverage
Real estate investment is the only place where you can long term loans for a low rate. Interest rate has been historically low over the last few years. Usually people put down 25% down payment when purchasing an investment property, which gives you a leverage ratio of 1:4. Assuming you have an investment property with enough rent income to cover all the monthly payments, whatever appreciation rate on your property will be amplified by a factor of 4 when calculating the return on your original investment, which is your down payment. If we amplify the national long term average of 3.5% by a factor of 4, we get 14% return, without considering any additional cash flow. If you get a property with positive cash flow after considering all the monthly payments and maintenance costs, the amount of risk you are facing is actually very small even if you are using a leverage ratio of 1:4. After making the initial down payment, you no longer have to pay anything out of your pocket. If you are lucky, you actually get some money into your pocket every month. After 30 years, the house is 100% yours. Mostly like, your value of your house more than doubles over 30 years. Since your original investment is only 1/4 the price, your return is at least 8 times over the full term of the loan. Of course, higher leverage comes with higher risk. However, when interest is low and rent demand is strong, the amount of risk is much more contained.
4. Large investment amount, Low liquidity
Well, a lot of people would like to say this is the shortcoming of real estate investment. I think it’s actually a merit. To purchase a $200K investment home, you need come up with $50K down payment, which a lot of people simply don’t have. Investment is a competitive game. Any sorts of entry barrier actually works to your advantage if the barrier doesn’t stop you. Except for flippers, most people don’t buy investment homes and sell it in the same year. Realtor commission and title insurance are big expenses. It is also a tedious and enduring process to sell a house. That actually pushes most real estate investors to be patient long term players, stripping them of the possibility of reacting to every emotional pulses. This kind of forced behavior will reward investors richly over a long time. The low liquidity also acts as a kind of investment barrier, keeping away some investors who simply don’t keep large capital trapped for years. Since the invested amount is so large and the return is good, it can really bring up the total return of the investor’s portfolio. I’ve met quite a few friends who do day trades and play penny stocks, thinking they are aggressive investors. When I ask how much money they are playing with, they say a few thousand dollars. Then after a deeper conversation, I find they have several hundred thousands of dollars of equity in their house or a lot of cash in their bank. Even if their stock position rise 100%, it doesn’t really affect the performance of their total asset much. If you want to move the needle, you have to put all your money to work and real estate is a good place to deposit a large amount of capital.
5. More pain, more gain.
Real estate is all about the location. It varies from city to city. It also varies a lot from zone or zone within a single city. That’s where a local individual investor can beat large institutional investors. It doesn’t make economical sense for large institutional investors to research every little detail in a single city. Neither do they bother to play with single family homes or small apartment units. That’s where individual investor with some decent capital can come in and bag some great returns if they do great research work and put in a fair amount of personal labor. When it comes to real estate investment, every additional effort that you make, every additional hassle that you are willing take, usually build an edge for you against other players. Many of my friends complain about the hassle and pains associated with managing real estate assets. In reality, it is these hassle and pains that create an entry barrier and reduces the risk of your investment.
To summarize it all, real estate investment is a type of low risk investment with stable return. Coupled with reasonable amount of leverage, the return is much higher while remains reasonably stable over the long term. It has entry barrier which keeps out the fickle mouse-clicking type of investors. Compared with stocks, it is so much easier to get better returns by doing more research work or physical labor.
DISCLAIMER: real estate investment is not risk free. If you don’t manage the risk properly, it can become a high-risk investment. I will talk about the risk factors associated with real estate investments in some other articles.