We’re all seeking the American Dream. For most of us the American Dream is incomplete without either one of two things, homeownership and/or the ability to own your own business. Real estate investing seemingly allows you to take advantage of both. You’re awarded the coveted title of homeowner while at the same time you create a source of income from your income producing real estate property. I’ve heard it stated many times that real estate is one of the great pillars of wealth.
I once heard a real estate investment speaker state that real estate has made more average people millionaires than any other industry. I don’t know the validity of his statement but I do know that millionaire status via real estate investing can often be misleading. It looks good on a balance sheet when your assets minus liability calculation suggest that you’re a millionaire—but are you liquid? Can you easily access your wealth from real estate at a moment’s notice without making price concessions or reducing your equity position by taking out a loan?
When I think of a millionaire I think of someone who has instant access to a lot of money. But the typical real estate investor is property rich, with marginal positive cash flow, and is highly leveraged with mortgage related debt. The typical real estate investor is just a couple of missed rental payments away from losing it all.
Real estate can indeed be a great investment. There are several advantages. Real estate serves as a hedge against inflation. Rental income creates a cash flow. There are certain tax advantages to owning real estate. Lastly, you can sell real estate property at a gain. The problem with real estate investing, influenced by the multitudes of infomercials, tapes, seminars and books is way too many people become real estate investors before fully understanding the business of real estate investing.
They’re sold on the idea that you can create wealth quickly by owning real estate. The other major selling point that leads people into real estate investing is that it’s easier to get financing for real estate than it is to get financing for a business. Combine the two ideas and you have a bundle of people believing real estate investing to be the easiest, quickest route to riches. Caught up in the dream of retiring from work and allowing the rental income to provide for your needs and wants will cause the most intelligent among us to ignore the mathematical alarm to take into account both upside potential and downside risk.
Rental property produces what is called passive income—meaning you do not have to materially participate to generate an income. Oddly enough the idea of passive income is another concept that tends to downplay the business side of real estate investing. If you think that you can sip lemonade in the sun while waiting for rental checks to pour in, here’s a glimpse of reality. Two-months out of a calendar year that may be the case but for the most part you will materially participate whether it be finding tenants, repair work, maintenance work, collecting rent and/or evicting tenants.
With the right knowledge, circumstances and expectation, real estate can be a great investment. Too often I run into people involved in real estate investing who lack all three essentials. For example, I once talked to a disabled woman on a fixed income who could barely maintain her own home, hold on to an investment property whose rent payments equaled the mortgage payment on the house. She had no cash reserves in the event of a non-rent payment, vacancy and/or maintenance/repair problem. This is a liability—not an investment!
On the other end of the extreme I talked to a young couple who own their own business. The business was moving roughly $40,000 per month yet the young couple had no idea where the money was going. In an attempt to supplement their income, they purchased a six-figure real estate investment property with an assumed $200 per month positive cash flow. My thinking on the matter, if you cannot identify where $40,000 is going, surely $200 will flow through your hands like sand. If they wanted to reap an extra $200 per month they could do a number of things and avoid the risk of $100,000 debt such as better manage cash flow on business, allocate a few more dollars to advertising or simply work a part-time job.
If you’re in the market to become a real estate investor there are a couple of things you should do before hand.
•Become knowledgeable about the business of real estate investing including forecasting costs of repair work, setting appropriate rental prices, understanding how to measure rate of return, knowing how evaluate risk versus reward, knowing how to screen tenants, etc.
•Get your personal financial house in order. You don’t want to lose the roof over your head because of an investment deal gone bad.
(Mortgage and Money Coach Damon Carr is the owner of ACE Financial. Sign up for Damon’s FREE online “Ask Damon” e-Newsletter @ www.allcreditexperts.com. Damon can be reached @ 412-856-1183.)