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!

I am in my early 20s, isn't it too early to start saving for retirement?

My niece is in her early twenties and asked me whether or not it is too early to start saving for retirement. To answer her question, I ran some simple calculations.

Let us start with a few assumptions:
Let’s assume that she will not need the money for forty two years (she will be sixty five), that the annual average rate of return on her retirement savings is eight percent, and that the annual rate of inflation is three percent.

Now we can look at two possible scenarios:

She does nothing for the next twelve years, and begins saving at the age of thirty five. She saves $10 thousand per year, and in thirty years she will have saved about $513 thousand. Discounting inflation, that would equal about $150 thousand today.

Or

She saves $2 thousand for the next two years (she will be a starving graduate student and will probably not have more to save); and then $5 thousand per year, increasing for inflation for the next fourty years. In fourty two years, she will have saved about $1,891,000 , worth about $550 thousand today.

In the second scenario, she would accumulate three times more money when compared to the first. It would allow her withdrawing $25-33 thousand a year in retirement relatively safely (in today's dollars). This would be my advice to her for right now.

Is it realistic? I think so. In two years when she finishes her Masters Degree most likely she will find a job that might pay around $50,000. So her retirement contributions would be about 10% from her pay.

Though this may not be enough to allow my niece the lifestyle that she would like to enjoy, it will get her into the habit of saving. It will also give her first hand experience with investing and allow her to see the results. As time goes by, the plan will change. Most likely, her income will grow, her lifestyle will change, her household will multiply, and her assets and liabilities will alter. But overall, she will have a sense of security about her retirement savings and her financial future.

Is it worth to overpay your mortgage?

This is the story of how a math mistake saved me money.

When my wife and I purchased our first home, I asked myself: Given a little extra disposable income, do I overpay my mortgage or invest that same amount in the stock market? After listening to a few financial pundits on the radio, I decided to overpay my mortgage. I did not do the math, I just relied on “expert opinions” to guide me.


Three and a half years ago, my wife and I purchased our second home and I decided that this time I would do it right. I did the calculations by applying the interest rate that I was paying at the time (5.65% over 30 years) and figuring in federal and state income tax. I came up with a return of about eight percent if I overpay my mortgage. So I started to overpay my mortgage instead of investing into the stock market. Well as it turns out, I had made a simple mistake in my Excel calculations. The return was actually less than four percent. I did not even realize my mistake until we refinanced our home at the end of December, 2008.

Thankfully, luck was on my side. Had I invested that money in the stock market, I would at this point have had negative returns. In the long run, however, I would not have lost out. I would have invested the dollar cost average over a number of years, buying stocks when they are high and when they are low, and my average return would have most likely beaten four percent.

After we refinanced, just before the new year, we got a 4.25% interest rate over 30 years. Figuring in federal and state income tax, we would probably receive a 2.9% rate of return. Having figured this out, I began putting my extra mortgage payments into the stock market indexes such as S&P 500, MSCI EAFE, MSCI US Small Cap 1750, etc., properly diversifying among all asset classes. Assuming that I will obtain approximately eight percent return over the long run and pay taxes on dividends and gains, I plan to be well ahead of the curve!

It is true that many financial pundits rave about overpaying your mortgage so that you can become debt free. However, if I can produce my mortgage balance from my bank account, that, to me, is also debt free. Furthermore, it is important to take into consideration the facts of life: what if you are overpaying your mortgage and you lose your job or are hit with extensive medical expenses? All of your built up disposable income is now sitting in the equity of your home and you must rely on bank loans (which you may or may not easily obtain).

So in case you are still wondering where I stand on the subject, here it is: overpaying your mortgage is not the best idea, assuming the interest rates are low as they are right now. If you have extra money, you are better off buying stock, mutual funds, or index funds. If you have the option, put the money in a Roth IRA so that it will grow tax free. Just do not try to time the market and switch frantically between investments. Be disciplined in this!

Shall I invest in the stock market now?

Recently, a friend of mine asked for my advice: is now a good time to purchase an S&P index fund for his retirement account?

Before I tell you what I think, a little history on the aforementioned friend:
For one, he is in his thirties and will probably not need that money for approximately twenty five years. Furthermore, he feels that during that time he will not lose sleep over market volatility. Not long ago, I showed my friend how to build a diversified portfolio in his retirement account – large caps, international, real estate, etc. At that time, we decided that he should have an S&P 500 index fund as a representation of a large cap stock. Since then, he has transferred money from his old 401K to a newly opened IRA account and is asking whether he should wait to invest in the S&P 500 or if he should buy it now.

This brings me to the facts:
- According to Professor Robert Shiller, since 1871 S&P 500 (or its equivalent until 1950s) never lost money in any 25 years period. See here for details.
- According to Ray Lucia, CFP the worst 25 years period since 1950s would have ~7.9% compounded annual rate of return.

While we cannot say for certain what the next twenty five year period bring, history serves as a good indicator. We cannot predict the stock market but we can use statistics to make educated decisions.

From a different perspective, we can also look at it this way: S&P 500 is more than thirty percent off its peak. Of course it might fall to extraordinarily low levels, but it may also rise – you just never know.

So back to the original question: what advice did I give to my friend? Buy the S&P 500 now. Base your decision on the long term trends. Do not get caught up in its daily performance and just have fun!