If you can stay away from loose money and loose women, your chances of success in life are pretty high. Investment property tends to fall in the former category, but tends to attract the latter. That’s a double-whammy of ‘bad decision’.
Cheekiness aside, I am absolutely not a fan of investment property. Now, investment property is not to be confused with simply buying a house. Investment property is buying a house that you don’t plan to live in, but that you do plan to rent out for a profit.
In my 30+ years of life, I have seen two types of people who predominantly buy investment property: old guys who have a real estate background and have been playing that game professionally for a long time, and hot-headed young men.
The appeal of investment property (IP) is that you will often hear many success stories from it. Combine this with the fact that the United States and Canada absolutely worship home-ownership and “property”, and you get a lot of people who think IP is genius. After all, it’s passive income, right? You just buy the house, hire a company to manage it for you, and have them rent it out, right? Easy money, right?
Wrong! Anything that promises to be easy money is lying to you. Again, chasing “easy” money is a path that leads a great portion of men to hell, or at least hellishness and remorse. It’s like your MLM friends who try to tell you that if only you can get 5 people to sign up, and those 5 people get 5 more people to sign up, you could be rich. RUN! RUN WHILE YOU STILL CAN!
But if investment property is so bad, why do we hear so many success stories from it?
First of all, a lot of this comes from survivorship bias. Most people don’t want to talk about their failures, but most people do want to talk about their successes. In a sense, you probably learn more from studying failure than you do from success, but that doesn’t sell books, or ears. It’s far more intriguing to read “10 Tips for Success in Life, Love, and Happiness!” than it is to read a memoir of failure. But once you learn about survivorship bias, you may be more inclined to read the latter.
This is why kids whose parents bought a house and never faced any serious financial setbacks will often receive the message that buying a house is the smart man’s way to live, so even though there are many cases when buying a house might be a bad decision, those kids will grow up with the message that it is always good. This isn’t their fault, it’s just that they never saw the other side of the story. That’s the danger of survivorship bias.
The famous Dave Ramsey, for example, found himself with incredible wealth at a very young age because he over-leveraged in real estate (IP). The prices went up, and the total value of his properties soared, but then something like bond yields tanked and the market experienced a crash of sorts. His creditors didn’t care, he still owed them on the leveraged principle. He went bankrupt. Now he’s a financial guru advocating to avoid debt like the plague, since it nearly ruined his life. (granted, that’s a small survivorship bias in its own right 😉 ). Property investors don’t tell you that side of the story, how leveraged they are, and how risky that leverage is. And the people who get bitten don’t want to talk about it. So there’s a whole community out there talking about how rosy and perfect it is, and how easy it is to make money with IP.
Even when investment property is profitable, it’s usually not profitable by very much. First of all, you are at the mercy of the market. It doesn’t matter how much you paid for the house, or condo, or whatever, if the going rate for an equivalent dwelling is $1,000 per month, you are going to be hard-pressed to get more out of it. After all, if a renter can go a few block over for practically the same thing at a cheaper price, why wouldn’t they? I don’t have a strong interest in real estate, but I’ve seen several different guidelines and rules of thumb for calculating whether a property is worth buying for this reason, and most properties do not have a great ROI. People think it would be great earning an extra $500 or $1,000 per month, but much of this profit can be wiped out by what you pay a property management company. If you were earning $500 per month and the property suffers a hot water heater failure that costs $3,000 to fix, a whole six months of profit just got wiped out. Or, say you have two months of vacancy. It’s not like your mortgage company just stops charging you. Now that money is coming out of the income that you spend on yourself, for your own house (if you have one)! Being responsible for an extra property like that is extremely risky.
And you’ll see internet arguments like this:
Former Investor #1: I got burned! I had a horrible tenant who did $10k of damage! Renters 4 life!!!
Current Investor #1: You had a nightmare tenant because you didn’t screen your renters properly. I’ve never had any problems, I make tons of money!
Former Investor #2: It was okay, but we were actually losing money, so we got out of the game.
Current Investor #2: My first tenant was horrible, but I learned my lesson and have had good tenants since. I make a small profit.
It’s all over the place. It’s unpredictable. And that’s because there are a ridiculous number of factors that go into whether you make money or not. But if you’re going to tell me there is only a 25% chance that I’m going to make serious money on the endeavor, forget about it. That’s not worth my time. Investing in my skills as a software developer can earn me far more money than the extra scratch I might earn owning a whole extra property. And that’s not even considering the mental overhead and stress of dealing with a property and tenants in the first place. I’m not getting rich off of my 401(k), but I set it and forget it every month. Having fewer shits to give is very desirable, in my opinion.
“Passive income, baby!” is a phrase that generally describes how some of these hot-headed young men go about it. I worked with a guy once who got really excited about personal finance and started doing crazy things to save money. It was really somewhat commendable, but then he got on the investment property bandwagon. “Why pay your mortgage when somebody else can pay it for you?” he would say. Well, that’s a cute sentiment, but it’s never that easy. As mentioned, you may experience periods of vacancy in which your extra house isn’t earning you anything and is actually costing you. Some people will diversify at this point by buying more properties that can help pay for vacancies at one, but now your debt is increasing and you’re taking on even greater risk. These little “real estate empires” can implode at any time, forget the fact that you are over-leveraged in one asset category, which is extremely risky (never forget 2007!).
Also, there’s really nothing passive about it. It’s possible you get a property management company to do the dirty work for you, but they don’t work for free, and that’s going to take a chunk out of your profits. And do you really think that paying them a few hundred a month is going to get them to sit down and dedicate weeks to a serious renter or structural issue you have? HAHAHA! Only what is required by law, per the contact you signed with them. $200 barely pays the office staff to a give a shit about your property, the company just brings a streamlined process and some automation to things. They are banking on the vast majority of their clients not having any problems at all, to cover the costs of those rare instances they have to actually dedicate serious time to an issue. In the end, you are still responsible for your property. And for many investors, that means dealing with late payments, calls at weird hours, damage, and other unpleasant things. Sure, hire a management company, but that could wipe out any profit at all, and wasn’t the whole point to make more money? You don’t get something for nothing.
The people who succeed at investment property usually eat and breathe real estate for a living. You either need to be like that, or you need to be lucky, and relying on luck is a poor strategy. If you don’t know what the property tax in your neighborhood averages, and you don’t know how to look it up, you either need to stay away from investment property or you need to gird yourself and prepare for some serious education. The people who win at investment property understand the business, its risks, pitfalls, and rewards. They know a good property from a bad, and they understand what realistic margins look like. And they need to have a considerable degree of self-awareness and an understanding of whether this lifestyle fits their personality or not. One does not simply pick up a book on how to do it and expect riches to flow.
Me? I have absolutely no debt. I make my money as a software developer. I live below my means, and I invest the difference. Those investments may average 7% per year, and will rise and fall with the markets, since I primarily invest in index funds. They will not balloon. They will not buy me a sports car, because I have no interest in that crap. I do my job, I make my money, and every two weeks, I watch that slice of progress transfer to my accounts. I do have to stay relevant and employed, but I don’t have to rely on luck, or historically large market returns. Instead of obsessing over making more money, I’ve rather chosen to focus on how to avoid needing the money in the first place. I feel pretty good about doing things this way. Is it exciting? Not really. Is it fancy? No. But it relies on solid principles and doesn’t require many external factors. In fact, it buys me a lot of time to focus on other things in life that matter more to me. There are many variations on how to go about life, but I consider this one to be pretty simple and straightforward, and it’s not terribly difficult to be earning more than I am, especially considering my lack of career ambition.
But hey, investment property is easy money, right?