Investing in real estate can be a great way to build wealth and secure your financial future.
As a result, this asset class has become a popular investment for many investors.
While there are many benefits to investing, there are also some downsides that many new real estate investors may overlook or not even be aware of.
The result is many headaches and the potential for lost money.
In this post, I discuss 10 pros and cons of investing in real estate.
By knowing these issues before you invest, you can ensure real estate is for you and possibly avoid some of the pitfalls.
10 Big Pros And Cons Of Investing In Real Estate
5 Pros Of Investing In Real Estate
There are many benefits of investing in real estate.
Here are the biggest ones that matter to most investors.
#1. Long Term Capital Appreciation
One of the biggest advantages of real estate is that it increases in value over time.
With real estate prices rising at an average annual rate of just under 5%, this is a low risk investment to make for building wealth and financial security.
While this rate of return is lower than other investments, like stocks, the level of risk of much less.
Also, real estate tends to keep place with inflation, so you know that you aren’t losing purchasing power through real estate investing.
#2. Real Estate Tax Breaks
Investing in real estate also gives you many tax benefits.
For starters, there are several write offs that can help reduce your taxable income and even increase the amount of money available to reinvest into other properties.
This includes the money you spend to upgrade your unit, to advertise, the mileage you drive to your property, and more.
As a result, this is one of the biggest reasons for investing in real estate.
Another tax benefit is leverage.
Leverage is the idea that you can borrow funds to increase your return on investment.
This basically means if you have enough equity in a property, then you can borrow cash against that property to invest in more property.
Or you can use the money from the equity for living expenses.
For example, let’s say your rental unit is worth $250,000 and you have a mortgage balance of $100,000.
You can take $150,000 from the unit and use it as you please.
This borrowing provides you with access to an additional level of investment and capital that would not otherwise be possible without it.
Depreciation is another benefit many real estate investors use.
This idea allows you to write off a percentage of the purchase price and upgrades each year you own the property.
This write off directly lowers your tax liability by offsetting your rental income.
Of course, as with anything tax related, these ideas have a lot of rules and exceptions to them.
- Read now: Learn the difference between a tax credit and tax deduction
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You need to make sure you investigate each thoroughly to determine how they will impact your financial situation.
#3. Steady Cash Flow
Another benefit of investing in real estate is the monthly cash flow.
While this benefit does not apply to all investors, it can be one of your best friends if you invest correctly.
Cash flow means that your monthly income from a property exceeds its expenses.
This includes mortgage payments, real estate taxes, property taxes, insurance premiums, and other maintenance costs you pay every month.
The result is a steady stream of income that can help you build wealth over time and provide you additional financial security.
As an example, let’s say your unit generates $500 per month in net rental income, excluding mortgage payments.
If the monthly expenses total $350, then you have $150 leftover each month as cash flow.
You can choose to reinvest this money into another property, use it to live off of, or whatever else you want.
#4. Allows For Leverage
As mentioned above, one of the biggest benefits to real estate investing is that it allows for leverage.
Using this method means you can use other people’s money to increase your wealth potential while lowering risk at the same time because you are not completely responsible if things go south.
For example, let say you have $25,000 saved up, but want to invest in real estate.
With leverage, you can use this money as a down payment on other properties while borrowing the rest of what’s needed for an 80/20 split loan.
In this case, 80% is covered by your lender and 20% is provided by you.
You own an asset that only required you put down 20% of its value.
Let’s say a property is worth $250,000 today and appreciates at 5% annually.
In 2 years, the value now stands at $275,625.
If you were to sell and get this asking price, you would pay 80% of the original loan back to the bank, in this case $200,000 and keep the remaining $75,625.
You just made over $25,000.
I kept this example simple to show you the power of leverage.
In the real world, you have to make monthly mortgage payments and deal with realtor fees, but you were able to get started with less than 100% of the money.
This appreciation allows you to tap into more equity that you can use to fund the purchase of more properties.
#5. Low Volatility
I mentioned how real estate increases in value and is less risky than stocks.
This is because the value of real estate doesn’t tend to drop.
While there are times when prices drop nationwide, like back during the financial crisis, this is rare.
At most, certain real estate markets will see no growth in prices or a small decrease from time to time.
But no matter where you are in the country, people need a place to live.
And this helps to keep real estate a stable investment.
5 Cons Of Investing In Real Estate
As great as the positives are, there are drawbacks to investing in real estate.
These are the things you need to know before you invest in property.
#1. Need A Lot Of Money To Start
One of the largest barriers to entry in the housing market is money.
If you want to buy a rental property, be it a single family house or an apartment complex, you are going to need a lot money to start.
Most of this money will be used for the down payment so you can secure the loan.
But you also need money to perform any needed repairs and to market the property for rent.
You also need money in the bank to cover ongoing expenses, maintenance issues and mortgage payments in the event your property goes unrented.
For example, let’s say you buy a $200,000 property and put down 10%.
This means you need $40,000 just to get the loan.
If rents in your area are $1,500 experts suggest you have at least 3 months of gross rent in rental reserves.
You should also have an extra 10% of rent per month saved for repairs.
This means you need an additional $4,950.
While there are ways to buy rental units with little money down or even no money down, this isn’t always the case.
As a result, if you want to get started with real estate properties, you will need a decent sum of money.
#2. Hard To Find Ideal Properties
Arguably one of the biggest drawbacks with rental real estate is it hard to find cash flow positive properties.
Sure there are many houses for sale at any given time, but not all of these make sense as an investment.
You need to figure out what your monthly payments will be and then see how much you can charge per month for rent.
Then you need to add back all the reserves you need to keep and still have some profit left.
After doing this, most properties fail, meaning they are cash flow negative, or they cost more than you can earn.
Finding the best cash flow positive properties is hard because other seasoned real estate investors find them before they even go on the market.
They have a network of real estate agents that clue them in to new houses coming on the market and the investors will strike a deal before the property even has a chance to be put up for sale.
#3. Time Intensive
Owning rental property is also carries a large time commitment.
First, there is the time it takes you to find the properties to buy.
As previously mentioned, this is difficult, so you will be spending a lot of time analyzing houses that turn out to not be a profitable rental unit.
When you do find a property, you then have to secure the financing, see the property, and negotiate the sale.
Once it is yours, you need to prepare it to be rented, advertise it, and show it to potential renters.
You will have to do background checks on them and if they rent from you, you need to collect the rent.
This is a lot of time, and more time than many new investors don’t account for.
#4. Potential Headaches
If the time spent finding properties and renting them out wasn’t bad enough, you have the headaches of tenants.
If they pay late or don’t pay rent, you have an issue.
Or if something breaks, you have to fix it.
Depending on the unit and your tenants, you could be spending a lot more time at your rental unit than you planned for.
While you can hire a property management company to handle repairs and maintenance, know that this isn’t free.
Most property management fees are 10% or more of the rental income.
So if you are charging $1,500 a month for rent, a management company might ask for $150.
This fee eats into your profit and you are back to the earlier issue of finding a positive cash flow property.
#5. Illiquid Investment
Finally, real estate is an illiquid investment.
When you invest in the stock market, you can sell stocks or bonds within minutes and have the cash on a few days.
With real estate, you have to list the property and wait for a buyer to show interest.
Then you have to negotiate and wait until closing to have access to your money.
This could take 3 months or more until you get your money.
An Alternative To Traditional Real Estate Investing
Thanks to technology, there is a new option to for investors looking for investment properties who don’t want to deal with the hassles of owning the physical asset outright.
This is real estate crowdfunding.
It works by pooling real estate investors money together to buy investment properties.
This allows you to get started with less money and a lot fewer of the headaches.
My favorite is Arrived Homes.
Once you create a free account, you can see single family real estate from across the country to invest in.
Once you decide to invest, you buy a share in the unit and then sit back and collect a passive income stream.
When the property sells, you earn a share of the capital appreciation as well.
And you can get started with as little as $100.
Click the link below to get started!
There are 10 pros and cons to investing in real estate.
As great as it sounds to earn passive income through this type of investment, know that it isn’t for everyone and there are many issues you have to deal with.
This isn’t to say you should avoid this asset class.
Real estate is a great investment and a great way to meet your risk tolerance in in your portfolio.
But instead of investing yourself, you might be better investing in a real estate investment trust, REIT, or with one of the newer investing platforms like Arrived Home.
These will get you access to the real estate industry without dealing with many of the cons listed above.