Boring Makes the Best Investment



There are many ways to invest in real estate. Some are inherently higher risk or more time consuming than others. For instance, a seaside vacation rental requires a thorough cleaning between every rental. Flipping houses requires a large cash investment and carries a high risk that you won’t make the big profit you planned on. Small, part time investors should be looking for properties requiring the least amount of work while delivering a dependable and reasonable cash flow.

If you’re new to real estate investing, you need to first realize that moving your money from liquid investments such as stock and bonds to illiquid investments like a rental property means the money is not likely to be available for you to spend for a long time. It’s the risk to earnings equation that is tempting. If you were earning 3% or 4% in the stock market, by taking more risk in the real estate market, you should expect a higher rate of return. Probably something in the 10% to 12% range.

Question mark under red roof

Cash-on-Cash Return

As a new investor, you want to go with a proven property rather than try turning around a unprofitable property. You want a property that will immediately deliver a monthly profit after accounting for all expenses. That doesn’t mean accepting the numbers that the seller offers you. Almost certainly, his or her costs are different than yours will be. The seller is going to make a profit selling the property and if you take out a mortgage it will be for more than what the seller was carrying.

Your due diligence needs to create pro forma numbers accounting for all income and expenses. Because pro forma numbers are nothing more than educated estimates, it’s wise to be conservative. You should estimate costs on the high side and income on the low side. If the numbers do come out on the positive side, you need to create a reserve account that you can build up over time. The reserve will get you through times of vacancy and cover unexpected repairs.

Low Risk and In Control

Many real estate investments involve partners or managers that you have to negotiate with or simply accept the decisions they make. When you’re not in control, you take on additional risk. These risky investments include tenants-in-common, developing real estate, fixer uppers, etc. The more people involved, the higher the risk.

For the beginning investor, the best way to own is with a private entity such as a limited liability company (LLC). You then own and control the entire property. You also realize all of the profits.

Buying Right

You might be tempted to buy a rental in the gang war zone of your city. The temptation comes from the low-low purchase prices. That is almost always a bad decision. People forced to live in these neighborhoods don’t have enough income to get out. That means they don’t have the money to pay monthly rent. You’ll have extended families huddling together trying to come up with the rent. Fifteen people living in a house intended for four people will do a lot of damage to your property. You’ll have frequent vacancies that will result in squatters moving in and graffiti scrawled on the walls.

Boring neighborhoods make for good tenants. It’s in the lower to middle income neighborhoods that you’ll find your lowest risk rental properties. Neighborhoods where tenants can pass a background and credit check. These are also your most reliable tenants. They’ll stay in the house for several years. You’ll have fewer vacancies and a reliable income stream. Boring often makes the lowest risk and best investment.

Brian KlineAuthor bio: Brian Kline has been investing in real estate for more than 30 years and writing about real estate investing for seven years. He also draws upon 25 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, a few short miles from a national forest in the Olympic Mountains with the Pacific Ocean a couple of miles in the opposite direction.

Comments

  1. Hi Brian, I totally agree boring is good and consistent and low risk, and just focusing on percentages can lead to bad decisions. The only comment I disagree with is “by taking more risk in the real estate market” relative to the stock market you can get a higher return in RE. To me, the stock market is much more risky than my boring long term cash flow based real estate investments. Fundamentally the stock market is more speculative and the real estate investments (I make) are based on todays numbers. Real Estate (a lagging indicator for the economy) follows the stock market (a leading indicator), so with a solid cash flow return of 6-8% (which beats stock paying dividends) I can still enjoy long term appreciation of 5-6% and have 11-14% total with very low risk. However, people say the stock market has been doing 15-20% a year in this bull run, and I say that’s great, because for my leveraged investments (e.g. 25% down) in real estate, market appreciation just amplifies my return and I again beat the market.

    • Brian Kline says:

      Victor,
      I completely agree with your comment. I probably could worded what I wrote a little better.
      Thanks for your insightful comment.
      Brian

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