The Myth About Real Estate

I am sure you have seen the promotions of seminars of how to get rich in real estate. While it is true that people can amass a fortune, real estate is a very tough business. Unfortunately, the barrier to entry is usually rather low as compared to some other things. This tends to attract a lot of people who have no idea what they are doing. They enter thinking they are going to mint a fortune only to realize they end up having it all foreclosed upon.

The allure of real estate is powerful. Sadly, the promise of riches, for most, are nothing more than a myth. It is a rough game and one has to be very mindful of what he or she is doing. One misstep can lead to ruin.

If one questions this idea, simply look at the situation with Evergrande. This is the real estate "miracle" on steroids. Certainly fortunes were made, right before they started to be lost. Here we see one of the largest companies in China, at least from the development standpoint, facing extinction over the next couple years.

As with anything, it is best to assess downside risk.

Image by @themastergamer

Buying A Home

Many start their real estate career with the basic idea of buying a home for oneself. Here is where we see things getting squirrely right from the beginning.

To emphasize my point, I will share a story of a buddy of mine. He (and his wife) returned to the town they grew up in at the end of the 1990s. They purchased a home using cash for $225K. There was a mortgage taken out when the son went to school for $40K but for the sake of our discussion, we will set that aside since it was paid back quickly as it was "backup" money.

They sold the house in 2016 as they were empty nesters. They downsized moving into a place with less square footage (and no yardwork). The sales price was right around $325K. Here we see a profit of $100K.

Of course, that is not the true numbers. We have to factor commission and other costs. There was also $10K in appliances they bought to help sell the house. Finally a new roof had to be put on since it would not have passed inspection (if you are in a place close to 20 years, you will likely have to pay for a new roof). The total of all that was close to $50K.

That still puts them ahead of the game by $50K, something that is never a bad deal.

It must be stated that neither the purchase, nor the sale, was at the peak or bottom of the market. They rode the early 2000s bubble up, and right back down. Naturally, since this was their residence, they were not flipping or looking at things from the investment perspective.

In other words, this was done about as well as you can do. Yet the profit of $50K is also an illusion.

The property taxes and insurance were roughly $2000 per year. There were also maintenance bills over the decades which added up to thousands of dollars. Anyone who had to replace a hot water heater, sprinkler system, or broken pipe knows how this all can add up.

So it is likely they just about broke even on the deal.

Here is where it gets interesting. Many will say that they saved on paying rent all those years. That is true. Breaking even on a house puts one way ahead as compared to paying rent for almost two decades.

There is a challenge here. One is the fact that the home was purchased with cash. This means there were no financing expenses. Run the numbers on this deal with an 80% mortgage and you see how things change.

Also, there is an opportunity cost. My friend simply did not want payment. Yet, if he dumped that money in the stock market (he pays his bills by investing), he is sure he could have averaged at least 5% yearly. Here is another pieces of the equation that turns the situation south.

Of course, that is not to say that people should not buy a home. This brings up one of the few points that I agree with Robert Kiyosaki about: a home is not an asset, it is a liability. Rental properties are investments, your home is a cost.

Investing

There are a lot of nuances to real estate. Watching the home flipping shows on television make it look so easy. What they do not show you are the properties that are rehabbed and sit, for a year or two. There was one who does a show out of Chicago. She was complaining she had to get the property on the market or she would be stuck carrying it all Winter. The deal was tight to begin with.

We looked it up online. It sold 18 months later; seems she held it two Winters.

A situation like that could bankrupt many wannabe real estate investors.

The myth about real estate is that people make money. Sure, some get very wealthy off it. However, they spend years learning what they are doing. It is not an easy trick. Also, simply buying a home does not qualify one to be an investor. They are two totally different things.

One of the biggest keys is to have your own team. The nuances I just mentioned most often require professionals. This can range from tradespeople to agents. Having people who are willing to do things in the manner needed on an acceptable time frame is crucial. Anyone who tried to get a reliable contractor in the last 18 months knows how tough that can be. It seems they are Johnny on the Spot during slow times yet won't return calls during the bull runs.

Having people who will show up no matter how busy things are (or are not) is crucial.

Another fatality is to look at price. Sales price is not the most important aspect to real estate investing. Instead, it is all about cash flow. Of course, price plays a part in this, especially if financing the deal. However, if the rents will not sustain the price, it matters none how "good a deal" it is. The cash flow will be negative and that does not lead to success in any type of investing.

In the US, we had three straight Presidents that talked about home ownership, the American Dream, and giving people access. The reality is many of those people ended up being foreclosed on due to the fact they had no idea what they were doing. Of course, the blame is always predatory lending and other headlines to cover for the fact these people should not have been buying a home. The reality is a certain percentage of the population does not have the financial acumen to be involved. If one is not willing to do the research, he or she should avoid it.

Yet people buy a house like they are buying a shirt. It is insanity.

For many the promise of real estate turns into a nightmare. For those who took the time to learn what is going on, it is a great way to build wealth. However, there is a reason why there are very few millionaire real estate investors running around. It is not an easy game.

In fact, for the majority of the public, it is nothing more than a myth.