Is Now a Good Time to Invest in Real Estate?

In today’s economy, I am often asked the same question: is now a good time to invest in real estate? Let us consider the factors that go into making this big decision by approach this dilemma from the perspective of the Average Joe. We will accurately assume that Joe does not have a spare billion dollars stuffed inside his mattress, itching to be invested in the real estate market.

Factor 1: Expectations.

It is important to be realistic about the appreciation, maintenance costs, and potential vacancy of any investment property. To help with this, I have done a little research. Based on the study of Professor Robert Shiller, the average U.S. home appreciated 3.78% a year between 1907 and 2007 and 4.87% between 1948 and 2007. This rate is nominal and does not account for inflation. When taking inflation into consideration, we are left with a one to two percent appreciation. Furthermore, real estate can be quite volatile. There are quite a few distributional peaks and valleys in Shiller’s real estate price data. Investing in real estate, even in today’s economy when real estate prices are low, might still not give you significant returns for quite a few years. Vacancy rates should also be an important part of your research. According to a recent article by Zack O’Malley Greenburg in Forbes Magazine, the average residential vacancy rate in the U.S. is currently 10.2%. Bloomberg.com shows a commercial real estate vacancy rate quickly approaching 16.7% this year. These high rates mean that the likelihood of you having to reduce your leasing costs to keep tenants on your property is also high. From this reduced profit, you will also need to maintain your properties to a satisfactory standard.

Factor 2: Leverage.

Real estate investors can rarely afford to shell out cash for the properties that they own. Even if they could, it would be an inefficient use of their resources as property appreciation can easily be eaten by maintenance, property taxes, insurance, and other similar expenses. Usually, investors put a down payment on the property and borrow the rest to make their property an asset. If the property appreciates and sells, the loan is paid off and the percent appreciation on the initial capital is quite high! On the other hand, property appreciation is not a guarantee and you can find yourself in a situation in which your home loan is being paid out of pocket.

Factor 3: Easy Access to Cash.

Unexpected things are always possible in the real estate market. You can end up with a vacant property or a laundry list of unexpected repairs. Not being able to afford these things can cause you to default on your mortgage and lose the property.
So regardless of the market, research your property and make sure that you understand what goes into managing a real estate asset. Assess your risk and be truly knowledgeable about what you are getting yourself into. If you find a property that suits your needs, don’t be lazy! Do the math to make sure it works. Double check to make sure that the rent you need to charge to make a profit is not exorbitant for the location or the property. Understand the duties of a landlord: late night phone calls, hunting down late rent, handling lawsuits of tenants who trip and fall on your property, etc.

Real estate is a risk and involves a lot of effort but there are things that you can do to reduce the risk like buying multiple properties. Hiring a managing company can help reduce the burden of landlord duties. More properties, however, means more loans. And hiring a manager means less profit. You need to decide what you are willing to put into this investment and what you would like to get out of it.

You might be thinking – what are my other options? You can also invest in real estate by investing in REITs, REIT mutual funds, REIT ETFs (indexes), and non-traded REITs. This will be the topic of a blog to come!