By Dr. James M. Dahle, WCI Founder
I've never been a big fan of “hype.” I'm kind of a boring, low-key person that way, but I believe that, as a general rule, good investing is boring investing. My thrills in life come from exploring the world, climbing, scuba diving, and other fun activities—not my portfolio. As a general rule, when investing is exciting and thrilling, you're at high risk to lose money. Those who want to make it seem exciting are usually selling something.
When an investor first comes into contact with the real estate investing world, they are often surprised by the amount of hype they run into. Sometimes it seems more like the annual meeting for a multi-level marketing company than anything else. There is blasting music, testimonials from the successful, and lots of encouragement that YOU can do it! Some people love that environment, but it can be a turnoff to others. I think it is worth looking past it rather than abandoning real estate just because of the hypey, rah-rah, cheerleader nature of its advocates.
However, there are three important lessons to learn from the hype, and they go a long way to explaining why it exists.
#1 Real Estate Investing Is Hard Work
Ask yourself, “Why do people need to be motivated to do real estate investing?” Well, reason No. 1 is that real estate investing is hard work. Talk to any experienced direct real estate investor, and they'll give you all kinds of ways in which they've hustled. Nobody needs to be given a motivational talk to go sit on a beach in Cancun. Or to sit on the couch and watch Netflix with a beer and a bowl of popcorn. Real estate investing is not like that. Think about all of the things you need to do to be a successful real estate investor:
- Learn how it all works/educate yourself. Books, courses, conferences, blogs, forums, internet searches, buying lunch for experienced investors, etc.
- Find a suitable property. Experienced investors will tell you they may look at 100 properties to buy one. That takes time.
- Buy the property. Most of us have bought a home at some point; was that fun for you?
- Fix up the property. It's a rare property that is move-in ready AND a good deal.
- Find, screen, sign, and orient new tenants. Remember the property itself doesn't provide rent; there must also be a tenant.
- Manage the property and the tenant—repairs, maintenance, paying expenses, collecting rent, and evicting tenants. Good systems help but don't completely eliminate the work here.
- Take care of the paperwork. Doing your own taxes is pretty easy . . . unless you're a real estate investor.
- Sell or exchange the property. What's that saying about the two greatest days of a boat owner's life? It also applies to investment properties.
The point is clear: direct real estate investing is like a second job. It doesn't take very many properties before it becomes a full-time job. Naturally, all of the work above can be hired out. There's a return-lowering cost to that, but the more you hire out, the less hard work it becomes. However, so long as you are the sole owner, you're still going to have to supervise those doing the work. You can avoid most of the work completely by investing passively, but there will still be some work of selecting and monitoring the investments or at least sub-asset class and the manager. Naturally, there is also a cost to being a passive investor, not the least of which is dealing with multiple state tax returns and paying significant fees to those doing the work for you.
More information here:
A Beginner’s Guide to Investing in Real Estate
How to Succeed in Private Real Estate Investing
#2 Real Estate Investing Is Risky
Another reason that there is so much hype around real estate investing is to induce you to take on significant risk. Although some return comes from the tax benefits and paying down the mortgage, the two main sources of return from real estate investing are the income (technically Net Operating Income) from the property and the appreciation of the property. The two largest risks of real estate investing are that something happens to those two sources of return:
Income Goes Down or Even Negative
There can be vacancies, tenants can stop paying, expenses can increase, repairs can be needed, property taxes can go up, and more. All of this reduces that Net Operating Income. You're running a business here, and you need to be good at it.
Appreciation Disappears or Property Depreciates
Properties do fall in value from time to time, especially when considered on “real” after-inflation terms, and sometimes they fail to appreciate for very long periods of time. Remember, most of the indices of real estate values are not adjusted for the fact that people are exchanging older homes for new homes. The actual rate of appreciation of older homes (i.e. the one you now own as a real estate investor) is not nearly as impressive. Consider a cherry-picked example: Detroit. The rate of appreciation in Detroit since 2000 is 0.23% per year. The average inflation since that time has been 2.43%. After inflation, the average home bought in Detroit since 2000 has fallen in price by a cumulative 31%+. And that doesn't account for the fact that many of those were new homes built after 2000. Imagine if I had also cherry-picked the time period (2006-2007 anyone?) in addition to the location. I sold the property I bought in 2006 nine years later for a significant loss, and that's not even including the negative cash flow. And it wasn't even in Detroit.
There are additional risks in real estate. One of the most common risks real estate investors take (and are certainly encouraged to take in those hypey books, conferences, and courses) is leverage risk.
“Other People's Money!”
“Get as much cheap leverage as you can!”
“Borrow, borrow, borrow!”
“Find 0% down deals!”
Leverage certainly boosts returns. The problem with leverage, of course, is that it works both ways. Imagine if you only put down 20% on a property and then it falls in value by 31% over the next couple of decades. Your entire initial investment is wiped out, and you wasted a whole lot of time and effort with that property. Another nasty part of leverage is that, at least when investing directly, you're usually signing personally for any debt associated with it. That means you can lose more than your entire investment. A -100% return is bad enough. A -300% return is particularly painful.
Real estate is also usually a very illiquid investment with high transaction costs, even if you're investing passively and even if you're investing on the more liquid debt side than the less liquid equity side. You SHOULD be paid more for taking on that illiquidity. If a boring old REIT index fund can provide 9% returns with daily liquidity and zero hassle, why would you ever buy a property yourself or enter an illiquid private syndication for that same return?
Investing is mostly about risk control. If your source of real estate investing information is not diving deep into the risks of real estate investing and how to carefully control them and make sure you're compensated for the ones you must take, keep looking.
More information here:
16 Different Ways to Invest in Real Estate
#3 Beware the Shovel Sellers
I have spent most of my life in the western United States, including Alaska. Part of our history out here includes numerous gold rushes and the interesting characters they attracted. Historians will tell you that, as a general rule, those who got rich in a gold rush were not the gold diggers. Those who got rich sold the shovels (and the food, housing, booze, and supplies) to the gold seekers.
In the real estate world, there are a lot of people selling shovels. They have a serious conflict of interest in getting you to be super-excited about real estate investing, to learn more about real estate investing, and to give it a try yourself. The shovels they sell are also frequently gold-plated. I've been amazed to see people who balk at paying a few thousand dollars for a real financial plan who think nothing of paying a real estate “coach” six figures to learn their secrets. Real estate courses and conferences are routinely the highest priced I've seen. If you question or negotiate the price, you are accused of “having a scarcity mentality.” If the courses or conferences are free, you need to ask yourself why anyone would go to the work of putting on a conference without an upfront cost. You'll quickly realize that, at that event, YOU are the product, or that the real sale will take place AT the conference, not before the conference. Just as those on Wall Street are notorious for transferring wealth from your pocket to their pockets, there are plenty on Main Street who would like to do the same. Consider the following shovel sellers:
- Course creators/directors
- Conference creators/directors
- Real estate attorneys
- Property managers
- General contractors
- Snow removal services
- Lawn care services
All of those people have a conflict of interest in getting you excited about being a landlord and real estate investing in general. They want to sell you the shovels to go dig for gold. Be careful not to buy too many gold-plated ones and realize they always make money (and sometimes much more than you do) whether you do or not.
Remember these three reasons when you encounter the real estate hype machine. If you can see through the hype, put in the work, manage the risks, and watch your costs, you can still make an excellent return investing in real estate. Just don't expect a risk-less, effort-less, rapid path to limitless wealth.
In an effort to help you to be successful at real estate investing, we are in the finishing stages of a new WCI online course called “No Hype Real Estate Investing.” It'll be coming out soon.
WCI’s No Hype Real Estate Investing is the best real estate course on the planet and the best way to get started in this exciting (and profitable) asset class. Taught by Dr. Jim Dahle and more than a dozen other experts, this course is packed with more than 27 hours of content, and it gives potential investors the foundation they need to learn about all the different methods of real estate investing. If you’re interested in real estate investing, you can’t afford to miss the No Hype Real Estate Investing course!
What do you think? Why do you think there is so much hype around real estate investing? What should the individual investor do about it? Is some of the hype good or helpful? Why or why not? Comment below!