Many people have built wealth with real estate. Not me.
I get it. The idea of buying a property, holding it for many years while it appreciates and spits out monthly cashflow is appealing.
Over the long run, real estate has been a great investment. Particularly unique to real estate is the ability to get a lot of exposure with relatively little cash via leverage.
Let’s say a property costs $1 million and you buy it with 20% down. If your net rental income (after expenses) is $2,000 per month your return on capital is 12%. This is huge, considering real estate is an asset that has historically maintained its value over time (except for some notable exceptions: 1930s Great Depression, early 1990s Canadian housing bust, late 2000s US housing collapse).
The optimist in me has often dreamed of becoming a local real estate tycoon. The realist in me thinks my optimistic side is an idiot.
Let me explain why I could never be a real estate investor or landlord:
- Valuations. I live in one of the most overvalued cities in the world. However, I also thought it was overvalued 5 years ago, yet prices kept rising. I was wrong then, so how am I to know when real estate prices will rise or fall. For it to make sense, my investment needs to be based on cash flows. For me to be comfortable, any real estate investment would need to be cash flow positive immediately and not dependent on market appreciation. I’m not sure I could get this in today’s environment. (Perhaps someone could show me otherwise.)
- I’m not handy. I can figure out the basics, but I’d have to pay a professional for anything beyond that. Perhaps with some time and investment I could build my skill, but unless rental income was enough to quit my job I’d need to outsource. That would cut my profit margin.
- I’m not good with conflict. As a landlord there will be times you need to be imposing, if not demanding. People will take advantage of you if they can. They’ll damage property, delay rent payments, sublet their apartment to a local fraternity. Personally, I’m too lenient and trusting to be a good landlord.
- Risk. Although real estate as an asset class historically is quite stable, investing a large proportion of your liquid net wealth into a single property is risky. Proper diversification in real estate requires one to own multiple types of property in different geographic areas. Others can mitigate concentration risk by truly understanding the property and regional profile, but I know I can’t (lack of time and knowledge).
- Liquidity. If I were a billionaire I could afford to have plenty of money tied up in real estate holdings. Unfortunately I’m not. Most people aren’t. Anyone locking their money up in real estate better be sure they don’t need the money for a long time.
I know plenty of people who have built wealth with real estate. I’m not saying it can’t be done. Rather, I’m saying I’m not suited to be a real estate investor or landlord. Instead, I’d rather buy a REIT and let the professionals take care of business while I sit on my a$$.
A big part of being a good investor is knowing yourself.
Charts de Jour
1: Q3 earnings estimates have dropped by 83% over the past few months, as the global economy tiptoes towards recession. This massive lid on analyst expectations tells me a lot has already been priced into the market.
In my opinion, market direction is dependent on two things: 1) the path for inflation and 2) Q3 earnings season. If inflation begins to moderate while earnings remains at or above expectations, we could see a rally. Many, however, are saying analyst expectations are still too rosy.
2: Inflation in Canada is beginning to slow. Watch this space!
3: Here’s what could wreck Q3 earnings. The global economy is decelerating at a pace not seen since the 2020 and 2008. When economies unwind this quickly, things tend to break within both the real and financial economy.
Bonus: If you’re slogging it out in a corporate bureaucracy you’re probably approaching the “strategic planning” part of the year. The output of this work often isn’t anything close to a real strategy. If you’re going through this process, you might benefit from this video featuring Roger Martin, former dean of the Rotman School of Management at the University of Toronto.