Real estate is a great investment but it may not be as great as everyone makes it out to be. I’ll start by saying that a lot of people are making a ton of money with real estate but it certainly isn’t the perfect investment as for as many people who are winning in real estate, there are many more losers.
Every year, billions of people look up the word “real estate” online. These search results provide an indication of just how many people are obsessed with real estate. Either they already own real estate or are looking to join the real estate game. But is real estate all that it’s made up to be? Well, here are five reasons real estate may not be all it’s cracked up to be!
Reason #1: Glorification By The Media
If you have watched television in the past month then you have probably seen at least one TV show on real estate. For instance, Home and Garden Television (commonly referred to as HGTV) has over 100 TV shows around the topic of real estate. These types of shows are designed to be very interesting and capture the attention of the audience. Therefore, they tend to show the good parts of real estate while leaving the other side of the story out.
You can see a show on any niche of real estate you can probably think of. There are shows on buying new homes or buying an older home, renovating it and then selling it. There are also shows about building custom decks and renovating homes and others on how to buy real estate in foreign countries. Then, there are the shows that show off the million dollar mansions where they present couples smiling about their new purchase. These types of shows create an obsession with real estate and this prompts many people to think about investing in real estate after watching them.
Moreover, there are a lot of advertisements on real estate on the media that makes it look like the best thing that could ever happen to you. They show you a thousand and one reasons why you should invest in real estate and more reasons you are missing out if you do not invest in it. Keep it in mind that you can make money from real estate but the way the media portrays it is far from the reality. Remember that they are marketers who want to make sales. They will do all it takes for you to hand them over your money which involves them showing you only the glamorous side of real estate. Unfortunately, there is another side of real estate that involves middle of the night calls from tenants and broken appliances that will cost you thousands of dollars to replace.
The media also makes it difficult to know who the professionals are. It is easy for anyone to claim they are experts and give advice but sometimes that advice doesn’t pan out. Always ensure you do your own research before you invest in any real estate if you want to be successful.
Reason #2: High Upfront Capital Requirement
Another reason why real estate is overrated is that it tends to have high upfront capital requirements however those in the real estate industry don’t want you to see it like that. In fact, financiers will tell you that you can start investing in real estate with no capital but this is because they want to loan you out the most money possible. So, with that being said, what are some of the upfront costs of owning a real estate?
The first sad reality of buying a home or any real estate for that matter is that you often must pay more than the list price to acquire the property. Simply put, don’t expect to pay the exact amount of the price of a property. Houses sell for above asking price quite often and this happens when supply is short in a market where demand is either stable or increasing. On top of this inflated price are the closes costs and land-transfer fees which only make this initial outlay worse.
This is why when you want to buy a new house you have to possess a large sum of money to pay your down payment. But this is not the only amount you will pay because there are other hidden fees associated with buying a new home that no one will tell you. Some of these hidden fees include application fees which are a nonrefundable amounts paid for doing business with a potential lender. Another fee you will have to pay is the appraisal fee which is the amount you have to pay before a loan is approved. It is paid to determine the value of a property. There are other fees such as the attorney fees, property taxes, mortgage insurance, a home inspection fee, first-year home owner’s insurance premium, and origination fees among others.
No one ever tells you that you have to pay this huge amount of money before you invest in real estate. Most lenders require you to pay a down payment of about 20% before they can approve a mortgage loan. That means if the value of the house is $300,000 for instance, the required down payment will be $60,000. This is a lot of money if you consider the opportunity cost of investing in other forms of business.
This same amount could have been used to buy some stocks which may yield higher interest than real estate and in a shorter period of time. And, depending where you live, if you used a real estate broker then you should be prepared to pay a percentage of the sales price of the home. Not to mention, all these costs are before you start paying exorbitant costs every month to keep the property maintained.
Number 3: Diversification Challenges
You will need to have a lot of money before you can think of diversification in real estate. You cannot think of owning properties in several places at the same time or great cities that are profitable if you do not have a lot of money. It can cost about $300,000 to $500,000 or even into the millions of dollars to own a single property in real estate. That is a lot of money and it is impossible to diversify when you have to spend such an amount of money on a single property.
With the same amount or less, you can own stock of different companies in different countries all around the world. This gives you the advantage of diversification. This means if one of your investments fails there will be another one that you can count on. But with real estate, if one of your investments should fail it can dramatically impact you because you have lesser options to diversify. Diversification in real estate is not usually possible except if you have a lot of money to invest.
Investing in real estate alone is like putting all your eggs in one basket especially when you invest in just one location. There is no assurance that a property will increase in value over the years. Also, you may have a problem with tenants struggling to make rent and this will affect your income.
Then, there’s liquidity. You can easily sell assets like stocks and bonds but in real estate, you may have to wait years before you get a buyer for your property. This will also cost you some money as you will need real estate agents to help you sell the property.
Reason # 4: Returns Lower Than The Stock Market
Although the stock market has been doing better over the years than the real estate from a growth standpoint, the media is not portraying it that way. While owning real estate has been portrayed as being a very attractive and ease to manage investment option, the same good grace hasn’t been placed on stocks. Those in the real estate market will make stocks out to be complex assets that only the rich should invest in. However, the stock market has historically provided a return of 7–10% annually whereas real estate has hovered around 2–4%. This means that the amount of profit you are going to get from investing in the stock market is higher than the amount of profit you are going to get from most real estate investments.
The liquidity of the stock market is also greater than real estate. If you need in a short period of time you can easily get it from your stock investment but seldom from your real estate investment. Most popular stocks can be sold instantly as long as you are willing to sell at the current share price. Moreover, you don’t need to hire an agent and market your asset to sell. With a few clicks on the computer you can turn those stocks into cash.
Moreover, selling stock is inexpensive but the transaction cost of real estate is still very high. You can easily sell your stock online for a flat fee of under $10 but the costs are significantly greater in real estate. This cost can sometimes be as high as 6%.
If you consider the stress involved, you will definitely prefer the stock market to real estate. You can simply invest in a stock and leave it while it pays you dividends quarterly. Real estate, on the other hand, is not passive as real estate agents want you to believe. You have to constantly maintain the property and look for buyers or tenants when you want to sell and all of this can be quite exasperating especially when you need cash quick!
Number 5: High Operating Costs of Homeownership
Most people dream of owning their own home one day and while this is an honorable dream, many simply do not understand the financial responsibilities that come along with it. When you rent, all housing maintenance costs are included in your rent but when you own, all the work is on you and when something breaks you have to either fix the issue yourself or pay hefty fees for a service technician.
When you own a home you are now responsible for all the maintenance and costs involved. When your stove breaks or your microwave no longer heats up your food there is no one to pawn off your problems to. And, there is no fixed cost for maintenance in a home as several needs may arise in the home that will require your attention. You may have a leaking roof, the plumbing may be leaking or any appliance in the home may need to be fixed. As a rule of thumb, you are advised to budget 1% of the value of your property for maintenance cost but there is no fixed cost for it.
Not to mention, it is mandatory to insure all your properties. The amount you pay for insurance will depend on the size of the home and some other factors based on the assessment of your “risk” level.
And if you bought the property on a loan don’t forget that you have to pay back your mortgage loan with interest every month.
But there’s more. After you’ve been in your home for a few years, you will likely want to redecorate or renovate your home. Simple redecorations could cost you a few hundred dollars but major renovations like your kitchen could easily be tens of thousands of dollars. This is the trap that many homebuyers fall into and given that renovations have been shown to be ineffective in raising the value of the home beyond their cost, they are futile when it comes to growing your wealth.
Therefore, while getting into real estate makes sense for most people, it like every other investment is far from perfect!