Investing in Real Estate Can be Satisfying and Lucrative OR It Can be Frustrating and Financially Disastrous
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Owning real estate has traditionally been a financial goal for many investors. Its tangible nature, the satisfaction of building equity in a property, and the prospect of selling property for large profits is appealing. Fortunes have been made in real estate and many have experienced the “passive income” that either residential or commercial tenants can provide. As attractive as a real estate investment opportunity can be, however, prospective buyers should be beware of the risks and pitfalls of investing in real estate for any purpose other than to have a primary residence.
First, one should recognize real estate’s lack of liquidity. Real estate usually requires a large immediate down payment and ties up those funds for the long term. People should generally invest in real estate for only the long-term and with funds they will not need to access in the next few years. If the property can generate rental income, then a liquidity need can be met, but a property’s ability to generate consistent income is far from a certainty.
Owners who expect to see consistent “passive” rental income should bear in mind the many factors that could disrupt those expectations. Rent control policies and tenant protection policies can “hamstring” property owners. In states such as California, for example, tenants receive numerous protections that can be onerous for landlords. It is very difficult to evict a tenant for any reason in California. Tenants who become insolvent and cannot pay the rent are common, as are destructive, “bad” tenants. Having to pay a mortgage on a property that is not generating income can be financially devasting. Still, a landlord may be “stuck” with a tenant who cannot or does not pay the rent either through job loss, injury, or simple refusal. During the COVID-19 era, remember, landlords were forbidden from evicting tenants who could not pay rent if the failure to do so was COVID-related. Investors should consult an attorney who specializes in homeowner’s rights before purchasing an investment property so they know what to expect.
Some of the other expenses that people often fail to consider are taxes, insurance, repairs, and upkeep. Plus, sometimes the only way to properly manage a property is to pay a management company to do so. Sometimes Homeowners Association fees are required. All these costs are considerable and, along with any months when a property may sit empty, can erode any profits from rental income or a sale.
Another risk is that of the property actually decreasing in value for unforeseen reasons. People often assume that real estate will always grow in value, but property values do decline. The character of a neighborhood may change, high interest rates may damper buyers’ enthusiasm, or geographical changes (eroding cliffs/beach, sinkholes, etc.) are just some of the many reasons why a property may decrease in value.
Again, real estate ownership can work out and real estate may be a valuable addition to one’s investment portfolio. It is not as easy of an endeavor as it may initially seem, though, and buyers should enter into ownership with their eyes wide open. If you are exploring real estate ownership, we can provide guidance and feedback. As financial planners with a fiduciary duty to our clients, Pacific Wealth Management serves as a first point of contact when our clients are considering any significant financial decision. Contact us to discuss your circumstances and priorities.