Thursday, April 18, 2013

Good To Know: Why Real Estate?

For the first post of the Good To Know segment I figured we should cover why invest in real estate in the first place. When starting to investment to obtain financial freedom, it only make sense to get your advice from the people who are living your dream. If you ask "How do you become wealthy?" you may get very different answers, but in the end the right answer will come from someone who as become wealthy.

So, what do the wealthy invest in? There are three answers to that question.

  1. Paper Assets (Stocks): Stocks holds a special place in my heart. That is where we started. But, having done both stocks and real estate; I have to admit there are some cons to stocks. There is a big learning curve, mostly because we learnt technical trading, not fundamentals. We learnt to read charts, what each individual candles are called, what patterns they form to recognise the trend, the support and points of resistance. To make decisions on the fly. Although I love stocks, based on what I've learnt; I'd have to say real estate is easier to start. (please take notes, I am talking of stocks, wealthy people do not invest in mutual funds or GICs)
  2. Business: The wealthy will own multiple business. It's a good investment. The difference is what a lot of us will view as a business is in fact being self-employed. If you are currently a business owner, ask yourself this; "How long can you leave you business without it been affected?" A business, in an investment term, should be able to run itself.
  3. Real Estate: If you've come to my blog, chances are you know real estate can be a good source of investment opportunity. The wealthy know this as well.

So lets discuss real estate. Why should you invest in real estate? Let's look at the PRO's and CON's.

  • Appreciation: In general, the value of a property goes up with time, this is called appreciation. With almost any other purchase the truth is the opposite, the minute you drive your new vehicle off the parking lot, the value of that car as taken quite a blow. But with real estate, well, land is the only thing we can't make anymore of. Now, we know better then to assume appreciation is guaranteed with the history in the US or even Calgary in the last few years. The real estate market will have it's up and downs, but in general, in the long term, the value will go up.
  • Forced Appreciation: Stocks will be worth what it is worth. They go up and down, and there is nothing we can do to control that. In real estate however, you can purchase a property, give it a new coat of paint, update a kitchen or bathroom, or maybe a little landscape and you can force its value to go up. You'll have to be very careful in taking into account the cost involved into such renovation but it's nice to know you can have some influence on the value of your property.
  • A Strategy For Any Market: The housing market will go up, will peak, and will fall just to start all over again. It is what it is. A four-plex in one province could cost less then a $100K while around here, in Alberta, that might not even get you a condo. The price to rent ratio may vary a lot from place to place. Property values are high here, and so is the rent, but on average the price to rent ratio as been better in the eastern provinces. It may be very hard to find a house to purchase so that it can be rented and make money after all the expenses are paid. This is how most may look at real estate investment. Buy a property, rent the property, and hopefully make money. Good idea, may not work everywhere. But there are other strategies. No matter where you are, you can make money in real estate in your area, all you have to do is use the right strategy whether it be Buy/Rent/Hold, Lease/Option, Wholesale, etc.
  • Cashflow: Real estate can put money in your pocket each and every month. It's amazing to realise that you can create a source of income aside from your job. People!! That is security. Peace of mind. Could be your retirement. Your financial FREEDOM!
  • Mortgage Paydown: So you purchase a property, and you rent it. Your tenant pays for the mortgage and expenses. This property can bring you money every month and eventualy your mortgage could be paid off completely and you didn't pay any of it. This is powerful stuff!! Does your mutual funds do this for you? No?!? Huh!
  • Leverage: Sometime you will come across comparison that will should what, on average, different investment will bring you over the course of a few years. Mutual funds will be compared to real estate and show that it is in the lead. $100K in mutual funds on average may make more then $100K in real estate. Well there is a few things to point out. First to obtain $100K in real estate you probably will only have to come up with 20%. They don't give you mortgages to get stocks or mutual funds. Also an average return on mutual funds can be very deceiving in how it's presented. Let's say the first year your $100K investment when up 100%; that would mean you would now have $200K. Great for you!! The next year it goes down 50%. Well take away half and you have and you are left with $100K. The average annual return in this case would be +100, -50 = 50 divided by 2 years and it's 25. On average, this stock as performed at a 25% gain annually. Well then how come after two years, you are back to square one?
  • Accessible To Everyone: Everyone, if they so choose, could invest in real estate. If you are a retired couple that live off the sale of your house by holding the mortgage since the house is paid for anyways. If you are a house owner who as lowered the mortgage payment by renting out the downstairs apartment. If you are an individual who is teaming up in joint ventures with other real estate investor to purchase multi-unit residential properties. Or if you are slightly down on your luck, with no money for investing and a bad credit, you could still wholesale properties without ever having purchased or qualify for a mortgage. Isn't it amazing that real estate can cather to everyone. If they so choose!
  • Refinancing: Let's say you have purchase an income property at a deal and you put down 20%. In the first term of your mortgage, you where able to spruce it up a little. Now it was already a deal when you purchased it, then you forced it's appreciation with some minor renos and the regular appreciation. It is time to renew your mortgage and you can take the appreciation out of your property and pay yourself that initial investment back. You are now making money on a real estate investment that as none of your own money tied up into it. Huh! What should you do with that returned deposit? Well gee I don't know?... Maybe do it AGAIN, and AGAIN.
  • Power Team: In real estate you surround yourself with your power team. These can be your lawyers, accountant, mortgage broker, realtor, property manager, etc. You do not have to understand and know every aspect involve in real estate financing; your power team can take that burden for you.
  • Emotion Interference: When trading stocks, one of the hardest thing we had to learn was to control our emotions. You place a trade, you have the target profit area where you want the stock to go and you also have your protective stop where win or lose you get out of the trade. So the plan is set. But now however, you are going to watch that candle move, in the wrong direction, possibly becoming a loosing trade. The temptation to adjust that trade is HUGE! Well in fact, at first, we did interfere and tweaked the trade to minimise our loss. In the end causing more loosing trades. Even when all we were risking was $5. The prospect of having a loosing trade was too great, and there was only so much time to react. With real estate, although emotions can get involved. There isn't that ticking clock demanding an immediate answer. You can step back, re-evaluate if needed, or contact your mentor who as more experience and get his or hers opinion.
  • Bad Tenant: There are bad tenants out there, I've had them, other real estate investor as had them and although they make for an interesting discussion topic when getting together with fellow real estate investors; they can be a big source of stress. This stress can be minimised! We describe lease-option or rent-to-own also as the perfect tenant program. Think about it, if you rent a house to someone who intends to purchase it, and they put a substantial deposit on this arrangement upfront; the chances of them becoming bad damaging tenants are low. These are future home owners, tenant-buyers. Also I minimise that stress by not dealing with the tenant at all. Property managers are always part of my power team when I purchase a new property. That's what they do for a living, they are good at screening to get good tenants into the rental units, they handle the calls or complaint and running after the rent money.
  • Work Of A Landlord: Want to go fix a broken sink at midnight on a weekday? Being a landlord can be a lot of work. It could easily become a full time job. And if it does become a job, guess what, that is no longer financial freedom. That is why, as I already mentioned I employ a property manager. Because honestly the chances of me hearing the phone at midnight are quite slim, and I know nothing about plumbing, and I live in the country on a farm; my rental properties are nowhere near me.
  • Limited Access To Mortgages: There will come a time, when investing in real estate, that the bank will feel you have enough mortgages. Trust me on that. Unfortunately your credit score, and debt to income ratio can only support so many mortgages. And after your personal home mortgage, your rental mortgages and your farm mortgages they may be reluctant to give you anymore money :) Doesn't mean you have to stop there. If that was the case, some of us would never even get to start. That is where joint venture partnership comes in. Team up with someone who as the money and the credit to obtain a mortgage. You bring in your skills and get  the deal together and they show up and sign the papers and can now share and profit from a rental property without having to put any work into it.
  • Power Team: Wait a minute!!! This one was in the PRO's now I'm putting it in the CON's? Well, yes. You see, everyone is different. For me, the power team is a PRO's, their combined skills and knowledge is definitely an asset. But for my husband, it can be more of a CON, because he hates talking on the phone, or making small talk with strangers. And until they are establish, your power team members will be strangers to you. In stocks, you are the only person involved whether you make money or not. You are fully accountable. In real estate, you have to rely on people, make sure they are as skilled and knowledgeable as they need to be.
There are many PROs and CONs, but in the end I feel the PRO's outweighs the other, but we all have different comfort levels. Where do you stand? What is your favourite PRO?

This video is a great interview discussing why we should invest in real estate.