Wednesday, December 02, 2009

Real Estate is not a Sure Gain

I know people who are wary of investing in stocks due to the bear market of the past year. Instead, they are putting their money into real estate. While I'm not opposed to real estate, I think believe that good real estate always makes money is based on some assumptions that underestimate the risk and expenses of keeping real estate.

Here are some of the assumptions that I believe can be misleading:
  • Real estate value always increases with time. Over long periods for time, this assumption is true. We all know the story of settlers buying Manhattan from Native Americans for some beads. However, over short periods of time the price of real estate can decrease significantly as in the case of the Pontiac Silverdome which cost $56 million to build in 1975 and recently sold for $583,000.

  • Real estate is easy passive income. In my experience, real estate usually requires quite a bit of work. For rental property, there are always maintenance and repairs, collecting rents and finding new tenants. For vacant land, there is also maintenance cost, in particular to keep others from using the property without permission. Finally, there are the usual taxes that need to paid.

  • Leverage multiplies the gain from investment. Yes, and leverage can also quickly also eliminate the equity in a property in a declining market, as shown the CNN article 1 in 4 mortgages 'underwater' .
  • Real estate is not a sure thing, as the recent recession has confirmed. As with any investment, due diligence needs to be done to determine if there is a reasonable probability of getting a good return.

    For more on The Practice of Personal Finance, check back every Wednesday r a new segment.

    This is not financial or real estate investment advice. Please consult a professional advisor.

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    traineeinvestor said...

    Absolutely agree - but it sure feels good when the rent comes in each month.

    Manshu said...

    I feel real estate is a good way for most people (who can afford it) to generate an additional source of income.