There was a time when investing in real estate was a sure bet. Property prices were constantly climbing, and landlords could easily collect rent in excess of their monthly expenses, even in the most competitive neighborhoods. But in the wake of the 2008 economic crisis, which was rooted in a housing bubble collapse, consumers are less sure about the long-term potential of real estate investments. Are these fears founded? Or is real estate still one of the best investments you can make?
Motivations for Investing
Let’s break down how real estate “works” as an investment. Real estate investors can focus on one or more of the following motivations in their work:
- Flipping. House flipping is the process of buying a house for a low amount, working on it to improve its appeal and overall value, and selling it within a few weeks or months for a profit. This idea is appealing to people chasing a quick profit, but the risks are enormous, and unless you’re experienced, it’s unlikely that you’ll find a consistent profit in this strategy.
- Rent profitability. Rent profitability is all about buying a property and renting it out to tenants. If you’re able to collect more in monthly rent than you’ll spend on ongoing expenses, you can pocket the difference as personal income. Your potential for success here depends on your practices as a landlord, as well as the price-to-rent ratio you’re able to achieve. Because this ratio varies based on your city and neighborhood, some places are more favorable for this approach than others. In any case, it remains a viable way to turn a profit in the modern era.
- Long-term growth. Most real estate investors focus on long-term growth; in other words, they count on the price of their property increasing over time as the main way to achieve a profit. There are some years when real estate prices fall, and some neighborhoods where price collapse, but for the most part, real estate prices always move up. This is partially because real estate is finite; we can’t create more land, so the value of existing properties keeps climbing indefinitely. The past few years have seen returns of 6 to 7 percent annually, though the long-term growth average for a given property is a bit lower.
The Risks
So are there increased risks to buying real estate, compared to past decades? Not necessarily. The biggest risk is buying a house you can’t afford and falling behind on payments, or dealing with a vacancy that jeopardizes your month-to-month profitability. Choosing the right property in the right neighborhood, and planning your financial model conservatively can help you avoid these catastrophes.
You can also find other ways to hedge your bets. For example, investing in real estate with a partner could reduce the risk you face as an individual by 50 percent, and buying rental properties with more available units could minimize the financial risks you face when there’s a vacancy (since you’ll still have revenue coming in).
Comparisons to Other Forms of Investing
Assuming you’re choosing valuable properties, and you’re compensating for costs by collecting rent, you should be able to see a decent return on your investment overall—5 percent per year or more. So how does this compare to other forms of investing?
- Stocks. The average annualized return of the S&P 500 index is something like 10 percent. This gives it more potential for growth than real estate, but it’s also slightly riskier. Plus, stocks aren’t tangible assets.
- Bonds. Bonds are slower-growing than real estate, usually offering an interest rate of 2 to 4 percent, but they are very safe.
- ETFs and index funds. ETFs and index funds are baskets of different assets, typically including stocks and/or bonds. They’re a useful way to hedge your bets against risks in these areas, and depending on the fund, may see a higher rate of return than real estate. But again, they aren’t tangible assets, and some neighborhoods may grow much faster than others.
- REITs. Real estate investment trusts (REITs) allow you to invest in properties the way you would an index fund. They provide you exposure to the real estate market overall, but may not be able to grow as fast as a property you hold as an individual.
The Bottom Line
The rockiness of recent years hasn’t shaken the foundation that real estate investing still provides. Real estate remains one of the best investments you can make, though it still has strengths and weaknesses you’ll need to take into account. The best investment strategy is one that’s diversified, with investments in multiple types of assets. That way, you’ll compensate for any individual weaknesses your holdings might have.
