Investing in Real Estate

I have been in the finance business for 20 years, and I personally own rental properties.  I understand the concept of using real estate to help save for retirement, but I would caution anyone before using leverage to accumulate wealth, whatever the investment may be.

Real-Estate-Investment-Principles-KeyI know several people near retirement age who own investment properties with mortgages that are “underwater,” meaning the owner owes more on the mortgage than the property is worth.  As a result, their prospects for retirement look grim.  In the early 2000’s, many people bought real estate with borrowed money, either as their primary residence or as an investment property.  Even though home prices have bounced back since the real estate market crash of the late 2000’s, many mortgages, and not just those on investment properties, are now “underwater,”

That leaves many people who own investment properties in an unenviable situation: sell the property at a loss and pay the difference in cash if they can afford it, or rent it out at monthly rates that in many cases are lower than the mortgage payment.  Both options lead to a financial loss.

One third ruleWhen asked about rental property as an investment, I tell clients to consider the “1/3 Rule”: no more than 1/3 of your net worth in your residence(s), no more than 1/3 of your net worth in rental real estate or illiquid businesses, and at least 1/3 of your net worth in liquid assets like cash, stocks, bonds, mutual funds, etc.  Like stocks and other investments, real estate can experience dramatic price declines. It is nearly impossible to buy only a small amount of real estate (i.e., $10,000 or so), and selling property isn’t as quick and easy as calling your financial advisor and placing a stock trade.  If you decide to buy investment real estate be careful not to become “real estate rich” and “cash poor.”  When the economy goes sour, cash is king, so always keep a little hay in the barn for emergencies. With proper diversification, an investor has options and won’t be forced to sell real estate and other investments at a time not of their own choosing.

I discourage investors from using borrowed money to buy real estate unless they are sure they can make the necessary payments or pay off the mortgage. Could your spouse go back to work if you lose your job? Did you make a large enough down payment (20% for a home, 30% for investment property) that you could sell the property without being underwater on the mortgage? Leveraged real estate deals have a way of being perfect storm magnets. I know folks who not only made their living in real estate, they also speculated on real estate deals, losing both their jobs and future retirement funds in the 2008 real estate crisis. Inevitably, the same time real estate values are dropping, both you and your tenant are bound to lose your jobs.
If you are interested in buying investment real estate, then I urge you to follow the 1/3 Rule  as well as the WealthMasters Milestones.  Be mindful of not owning too much of any one type of investment, or using excessive leverage to reach your retirement goals.  Buying rental properties with borrowed money can easily become a nightmare if you find yourself pinched. If your properties lose value, the lenders are going to expect you, not the renter, to make good on your mortgage payments.

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