Recently, I had a client express her concerns about the Government, long-term concerns about debt, and the effect of the economy. I have shared my thoughts on these in other posts, so I am not going over that now. It was her follow-up comment, "I think I want to put all my money in real estate because hard assets and tangible assets will be able to retain their value." Although there is some truth to her statement, we had to walk through this.
Often in my job, clients get in their mind from media, friends, or family that if they just put all their money in one investment, this one investment is the magic bullet to every conceivable long-term situation. The most common ones are cash, real estate, and commodities and with commodities, specifically gold. I will talk about the mistakes investors make in the three-part series. The first part will be real estate.
Setting the scene: In complete disclosure, I enjoy real estate investing. As I worked with Matt Rehak and Paul Smeton, the founders and owners of HFG, I learned so much from them. They were avid real estate investors, investing in everything: apartments, single-family homes, beach properties, and commercial properties. Watching them, along with other clients, I saw how lucrative it can be. As a result, I bought the building that HFG currently resides in when they decided to sell. Additionally, I learned from them and others that if you are going to invest in real estate, you need to do your homework and know what you are doing.
Here are four common mistakes clients make when they consider real estate:
(1) They feel that real estate values always go up, and they are recession-proof - I have heard clients tell me that real estate always goes up. Like stocks, the long-term trend is that the value of real estate goes up over time. It is natural as inflation occurs. However, just like stocks, there are periods when real estate can go down and go down drastically. In the recession of 2007-09, real estate was hammered. The reason people do not feel real estate is as volatile as stocks is that real estate prices are not tracked daily like stocks. There is an erroneous assumption that just because I do not see the price decline on a statement, it is not there.
(2) Real estate makes more money over the long term than stocks - That is the belief. However, there is no better way to make money in the long term than to invest in stocks. Two points exemplify this:
(A) I was at a conference listening to an analyst discussing the value stocks provide by investing in the best-run companies. One of the top objectives of the CEOs of top companies is to maximize the company's value. The analyst said something so profound. If real estate were a better investment, these CEOs would exclusively buy real estate to maximize their return compared to investing in the company, buying other companies, or doing share buybacks.
(B) Nick Murray recently wrote an article that a house Groucho Marx paid $27K in 1926 in NYC recently sold for $2.3 million. Had Groucho taken that money and invested in the best-run companies of that time, that figure would be closer to $304 million. He even accounted for tax implications that both would have to go through with capital gains taxes for stocks and real estate taxation, insurance premiums, fuel bills, and repair and maintenance.
(3) They believe that real estate investing has no risk. I have watched a lot of successful real estate investing, which can be lucrative. However, it is not for the faint of heart or novices. One has to know what they are doing. Real estate has considerable risks that one should be aware of. Here are some: (1) The price you buy it at really matters. I learned this from Matt and Paul. If you pay too much for financing, you may not make enough money for it to be profitable (2) you can have damage that your renters or tenants do not pay (3) the area you buy in could change and be less attractive. (4) significant events like COVID-19, where people work from home.
(4) To take point 3 a little further. If you are buying real estate as an investment, you want it for cash flow. You invest in stocks, bonds, insurance, etc., for future cash flows. The most important thing if you invest in real estate is treating it like a business where cash flow is king. It is crucial to have consistent cash flow. When buying real estate for investment purposes, you have to make sure the cash flows are reliable so that you can pay your mortgage or finance charges, or if it is paid off, it is producing income for you. We focus on retirement income planning, which is all about cash flow. You have to know that even though revenue from real estate can be reliable, it is not guaranteed like pension, SS, or income annuity.
As I said from the outset, I enjoy real estate investing, which can be part of a client's investment portfolio. Be careful in adopting the belief that real estate does not go down, has no risk, has no volatility, and the long-term returns beat the long-term returns of the best-run companies in the form of stock. If you want to discuss how it fits into your retirement income plan, please reach out to us.