Why Invest Early and Why Real Estate?

People often ask me questions about investing in real estate. I assume due to television shows, infomercials, large personalities such as Donald Trump, and other reasons, people find real estate to be an intriguing and often glamorous industry and topic of discussion. While I don’t think real estate is as easy or glamorous as TV makes it out to be (quite the contrary), I’ve been fortunate enough to have had some success in multiple areas of real estate investing, and although writing is not my forte’, I’ve decided to share some of that knowledge with you. As Warren Buffet has said, “It’s good to learn from your mistakes. It’s better to learn from other people’s mistakes.”

Depending on the feedback we receive, and how much time I have available to do this, I’ll share information ranging from the financial metrics of different types of deals to whether to sell or hold a real estate investment. We’ll cover some general topics, and we’ll dive into some more detailed aspects along the way. However, the first step should be to address why it’s so important to invest in the first place, the benefits of beginning early, and why real estate in general is a good investment.

Most people who invest will do so using stocks and bonds. The stocks will give them an opportunity for higher returns, and the bonds will give them stability and lower risk. We’ll work real estate into the discussion in a minute, but it’s important to understand the benefit of compound interest. The key here is to reinvest the money you make on your investments back into more investments. Be disciplined…do NOT take the money out to buy a boat! Unless it’s a necessity, the money that goes into your investments should STAY in your investments. Compound interest is an extremely powerful tool:

For example, if you plan to retire at age 60, and if you invest $500 / month ($6k / year) at a 7% annual return beginning at age 45, and you continue to reinvest your profits, you will have $161,328.32 when you retire.

However, if you invest $500 / month ($6k / year) at a 7% annual return beginning at age 22, and you continue to reinvest your profits, you will have $1,107,841.75 when you retire, even though you’ve only contributed approximately $228,000. That means you’ve increased your money by almost 5 times at only a 7% annual return!

Now that we’ve made that point, let’s throw real estate into the mix. For purposes of this discussion, we’ll use income properties, or longer-term investments which are leased out for revenue (We’ll talk about “flips” in another post). One of the downsides of real estate is its general illiquidity compared to other investments. In other words, if an emergency arises, and you need money today, you likely can not just sell real estate this afternoon like you can with a stock. This is an important distinction, and a main reason why, even though our business IS real estate, we still put money into stocks and bonds.

Our philosophy, which is a common one from any intelligent advisor or investor, is to diversify. Not all of the time, but often times, different investments act differently in different market conditions, and this acts as a “hedge” on your portfolio. For example, when the economy is having trouble, and your stocks lose value, it’s not impossible for the demand for apartments or mobile home parks to actually increase, and as such, the profitability of those types of investments increases as well.

According to the “American Association of Individual Investors” (2017), most individual investors have a portfolio breakdown as follows: 66% equity, 16% fixed income, and 18% cash. However, according to “Q3 Tiger 21 Asset Allocation Report” (Q4 2017 – Q3 2018), Super High Net Worth Investors (600 members with a total of $50 Billion in net worth) only put 42% of their portfolio in equity, fixed income, and cash. The remainder is in alternative investments including Private Equity, Real Estate, Hedge Funds, etc. According to this report, those Super High Net Worth Investors put 28% of their portfolio into real estate!

Whether you are looking at High Net Worth Investors, endowments, pension funds, etc., the majority of sophisticated investors have a substantial Alternative Investments portion of their portfolio, and a large portion of that Alternative Investment portion is often times real estate.

In addition to the benefits of diversification, we’ll highlight one other benefit to investing in real estate at this time. For starters, due to the tangible nature of real estate and the stability of the asset class over the long term, real estate is generally an asset class where you can leverage your money with debt from the bank. We will get into this in more detail in a subsequent report, but let’s look at the following scenario:

You buy a property for $100k.

You put in $20k of your money, and you get a 20-year bank loan for $80k.

The rent from the property pays your bank loan and also nets an additional $1,400 per year in profit.

On the surface you say, “I’m putting in $20k of my money, and I’m making 7% on my money. Why don’t I just invest in the stock market?” However, and here is the kicker, at the end of 20 years, you have paid off the $80k loan, and you own the entire $100k property outright. So, your $20k initial investment has now made you $28,000 cash, and it has also increased your equity by $80k. The $28k cash and the $80k equity gain means your pre-tax net worth increased by $108k over 20 years. In essence, you averaged a gain of $5,400 / year on a $20k investment, or as a percentage, you averaged a 27% return PER YEAR over a 20-year time frame! What’s more impressive is that this does not take into account appreciation of the rents and property value, reinvesting (or compounding as we discussed above) the $1,400 profit each year, value-add opportunities to raise rents, or other financial benefits such as the tax benefits of real estate which we’ll touch base on in more depth in a subsequent report.

I think the key here is to realize that long-term real estate investing can be a beneficial investment tool for wealth accumulation. It is not quick, and it is often times not easy, but while there are absolutely risks, and there are downsides such as illiquidity, there are also reasons as to why it can be a positive attribute to your investment portfolio. With that being said, I don’t think that means you have to become an expert on real estate or go buy a property on your own. If you have the capability to do so, and you want to do so, by all means, we support you. However, this simply means that we like the idea of a portion of an investor’s portfolio to be in real estate. If you’re capable and up to the challenge, you can be an active investor and do this on your own. Or, more than likely, you can simply be a passive investor in someone else’s project who IS an expert on real estate. At the end of the day, you need to make the most intelligent, risk adjusted decisions to protect your money and grow wealth at the same time. While making money is great, I’d like to use our second Warren Buffet quote of the day, “Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.” #realestate #incomeproperties #investing

KEY NOTES / DISCLAIMERS:

1.) I am NOT a licensed financial advisor, an attorney, or a CPA. This information is simply based on my knowledge and experience. You should do your own due diligence and consult with your advisors before making any investment decisions.

2.) All calculations are done pre-tax.

REFERENCES:

1.) “American Association of Individual Investors” (2017)

2.) “Q3 Tiger 21 Asset Allocation Report” (Q4 2017 – Q3 2018)