Why is there so much hype in real estate investing?
By Dr. James M. Dahle, Founder of WCI
I’ve never been a big fan of “hype”. I’m a boring, low-key person in that way, but I believe that as a general rule, a good investment is a boring investment. My thrills in life come from exploring the world, rock climbing, scuba diving and other fun activities, not from my portfolio. Typically, when investing is exciting and exciting, you are at a high risk of losing money. Those who want it to sound exciting usually sell something.
When an investor first comes into contact with the world of real estate investing, they are often surprised by the hype they are faced with. Sometimes it feels more like the annual meeting of a multilevel marketing company than anything else. There’s loud music, success stories and lots of encouragement that YOU can do it! Some people like this environment, but it may put off others. I think it’s worth looking beyond rather than abandoning real estate simply because of the hypey, rah-rah, cheerleader nature of its advocates.
However, there are three important lessons to be learned from the hype, and they go a long way to explaining why it exists.
#1 Real estate investing is hard work
Ask yourself, “Why do people need to be motivated to invest in real estate?” Well, reason #1 is that real estate investing is hard work. Talk to any experienced direct real estate investor, and they’ll give you all sorts of ways they’ve hustled. No one needs a pep talk to go sit on a beach in Cancun. Or to sit on the sofa and watch Netflix with a beer and a bowl of popcorn. Real estate investing is not like that. Think about all the things you need to do to be a successful real estate investor:
- Learn how it all works / educate yourself. Books, courses, lectures, blogs, forums, Internet searches, buying meals for experienced investors, etc.
- Find a suitable property. Experienced investors will tell you that they can look at 100 properties to buy one. That takes time.
- Buy the property. Most of us have purchased a home at some point; was it fun for you?
- Repair the property. This is a rare property that is move-in ready AND a bargain.
- Find, screen, sign and orient new tenants. Remember that the property itself does not provide rent; there must also be a tenant.
- Manage the property and the tenant – repairs, maintenance, paying expenses, collecting rent and evicting tenants. Good systems help but don’t completely eliminate the work here.
- Take care of the paperwork. Doing your own taxes is quite easy. . . unless you are a real estate investor.
- Sell or exchange the property. What does this say about the two best days in a boat owner’s life? It also applies to investment properties.
The point is clear: direct real estate investing is like a second job. It doesn’t take many properties before it becomes a full-time job. Naturally, all of the above works can be hired. There is a cost-reducing return on investment, but the more you hire, the less difficult it becomes. However, as long as you are the sole owner, you will still need to supervise those doing the work. You can avoid most of the work altogether by investing passively, but there will still be work to select and monitor the investments or at least the sub-asset class and the manager. Of course, there is also a cost to being a passive investor, not the least of which is processing multiple state tax returns and paying hefty fees to those who do the work for you.
More information here:
A beginner’s guide to investing in real estate
How to Succeed in Private Real Estate Investing
#2 Real estate investing is risky
Another reason there is so much hype around real estate investing is to entice you to take big risks. Although some return comes from tax benefits and mortgage repayment, the two main sources of return from real estate investing are the income (technically the net operating income) from the property and the appreciation of the property. property. The two biggest risks of real estate investing are that something happens to these two sources of return:
Income decreases or even negative
There may be vacancies, tenants may stop paying, expenses may increase, repairs may be needed, property taxes may increase, etc. All of this reduces this net operating income. You run a business here, and you have to be good at it.
Appreciation disappears or property depreciates
Properties lose value from time to time, especially when viewed in “real” terms after inflation, and sometimes they do not appreciate for very long periods of time. Remember that most house value indexes are not adjusted for the fact that people are exchanging old houses for new houses. The actual rate of appreciation for older homes (i.e. the one you now own as a real estate investor) is not as impressive. Let’s take a hand-picked example: Detroit. The appreciation rate in Detroit since 2000 has been 0.23% per year. Average inflation since then has been 2.43%. After inflation, the price of the average home purchased in Detroit since 2000 has fallen 31% and more. And that doesn’t take into account that many of them were new homes built after 2000. Imagine if I had also chosen the time period (2006-2007 anyone?) in addition to the location. I sold the property I bought in 2006, nine years later, at a significant loss, not to mention the negative cash flow. And it wasn’t even in Detroit.
There are additional risks in real estate. One of the most common risks real estate investors take (and are certainly encouraged to take in these buzzy books, lectures, and courses) is leverage risk.
“Other people’s money!”
“Get as much cheap leverage as possible!”
“Borrow, borrow, borrow!”
“Find 0% deals!”
Leverage certainly increases returns. The problem with leverage, of course, is that it works both ways. Imagine if you bet only 20% on a property and its value drops 31% over the next two decades. All your initial investment is wiped out and you have wasted a lot of time and effort with this property. Another unpleasant aspect of leverage is that, at least when investing directly, you usually personally sign any debt associated with it. This means that you can lose more than your entire investment. A return of -100% is bad enough. A return of -300% is particularly painful.
Real estate is also generally a very illiquid investment with high transaction costs, even if you invest passively and even if you invest on the more liquid debt side than on the less liquid side of stocks. You SHOULD be paid more to assume this illiquidity. If a boring old REIT index fund can provide 9% returns with daily liquidity and zero hassle, why would you buy a property yourself or enter an illiquid private syndication for that same return?
Investing is primarily a matter of risk control. If your source for real estate investing information doesn’t dive deep into the risks of real estate investing and how to carefully control them and ensure you’re compensated for the ones you have to take, keep looking.
More information here:
16 different ways to invest in real estate
#3 Beware of shovel sellers
I have spent most of my life in the western United States, including Alaska. Part of our history here includes many gold rushes and the interesting characters they attracted. Historians will tell you that as a rule, those who got rich in a gold rush were not the gold diggers. Those who got rich sold the shovels (and food, lodging, liquor, and supplies) to the gold diggers.
In the real estate world, there are a lot of people selling shovels. They have a serious conflict of interest to get you super excited about real estate investing, learn more about real estate investing, and try it yourself. The shovels they sell are also often gold plated. I’ve been amazed to see people who are reluctant to pay a few thousand dollars for a real financial plan and who don’t mind paying a six-figure real estate “coach” to learn their secrets. Real estate courses and lectures are generally the most expensive I have seen. If you question or negotiate the price, you are accused of having a “scarcity mentality”. If the courses or lectures are free, you have to wonder why anyone would want to hold a lecture without an upfront cost. You will quickly realize that at this event YOU are the product, or that the real selling will happen at the conference, not before the conference. Just as those on Wall Street are known to shift wealth from your pocket to their pocket, there are plenty on Main Street who would love to do the same. Consider the following shovel vendors:
- Course Creators/Directors
- Conference creators/producers
- Real estate agents
- Real estate lawyers
- Property managers
- General contractors
- Snow removal services
- Lawn maintenance service
All of these people have a conflict of interest to get you excited about owning and investing in real estate in general. They want to sell you the shovels to dig for gold. Be careful not to buy too many gold plates and realize that they always make money (and sometimes a lot more than you do), whether you do or not.
Remember these three reasons when you come across the real estate hype machine. If you can see through the hype, get to work, manage risk, and watch your costs, you can still get a great return investing in real estate. Don’t expect a risk-free, effortless, and quick path to unlimited wealth.
In an effort to help you succeed in real estate investing, we are about to complete a new WCI online course called “No Hype Real Estate Investing”. It will be out soon.
Don’t forget to sign up for the free White Coat Investor Real Estate newsletter which will alert you to opportunities to invest in syndications and private real estate funds, including most of those in which I invest.
What do you think? Why do you think there is so much hype around real estate investing? What should the individual investor do about this? Is some of the hype good or useful? Why or why not? Comments below!