Is Investing in Real Estate Right for You?

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. How does real estate stack up as an investment? Joining me to discuss that question is Ilyce Glink. She is CEO of Best Money Moves, and she is also author of a new book, 100 Questions Every First-Time Home Buyer Should Ask.

Ilyce, thank you so much for being here.

Ilyce Glink: It's a pleasure.

Benz: Your new book is geared toward first-time homebuyers, but you have done a lot over your career on the topic of investing in real estate. I want to talk about that for our viewers. Many of them are avid investors in stocks and funds and exchange-traded funds, but they might be considering some sort of investment in real estate, in actual physical property. Let's discuss the benefits of such an investment.

Glink: One benefit is the new tax law. Things that are no longer going to be deductible are not as limited when it comes to investing in real estate. A lot of the way that you deduct those costs and expenses and account for the income, I think, is going to be favorable to taxpayers. You may want to look at that just as a little aside. Retirees are increasingly looking at investing in real estate as a way to augment retirement income and to leverage some of the other expense and time that they have available.

I'm getting to thinkglink.com, which is my website for the book and for my other real estate stuff, I'm getting a lot of interest from people who are in their 40s, 50s, and 60s asking basic questions about investing in real estate. I cover some of that in the book as well, because they are familiar with the process of buying, but what they are not familiar with is thinking about how investments in real estate actually work. They are not familiar with the tax laws, how things get accounted for. They may not realize all of the great deductions that they get, and they may not realize that when they sell the property, there's a way to defer any gains on that property if you roll that into a new investment with a 1031 exchange. There's lots of different opportunities and ways to slice and dice.

Benz: Naturally, people are attracted to this idea of, if I have this property that I can rent out to someone, especially if I'm getting close to retirement, it's a way of augmenting whatever income I have from my investment portfolio or that I'm getting from Social Security or a pension. That's obviously a big attraction. Let's talk about some of the drawbacks though. Everyone is not cut out to be a landlord, right?

Glink: Oh, my goodness, no. My husband and I talk about this all the time because we have a couple of investment properties, and I just know he would love to get rid of them. He is a real estate lawyer, he is the perfect person to help manage it. But it's just one more thing to do. When you are in your 40s and even 50s, you typically have either school-age kids or they are a little bit older, they still require a lot of time. You've got your partner or your spouse and that requires time. Work by this time is getting a little bit more. It becomes yet one more thing to manage.

On the other hand, I have people who have reached out to me over the years when I have talked to them about it and they have come back 10 years later and now they own 25 properties. They see an opportunity--this is how it all starts--you see an opportunity near where you live, and you think to yourself, wow, that house is in really yucky shape, but if the bones are good and I could probably fix that up and rent that out. All of a sudden, without even looking at it, you've bought that house and now you are in the process of doing it, where you are going to learn a million lessons. It's not as easy as it looks. If you stick with it and you are thoughtful about what you spend and what you charge and you do some homework, it's a very nice way to augment retirement income.

Benz: Another thing I think about, though, is in addition to maybe some of the maintenance responsibilities that you might have, there's also the issue of if I invest in a portfolio of mutual funds or ETFs or something like that, I've got a lot of diversification, lots of different types of companies and so forth. If I think, say, $200,000 in this property in my region, I'm inherently less diversified. How should people approach that issue?

Glink: It's a big problem. Because typically, people have the biggest part of their net worth in their house …

Benz: Right. In the house that I live in.

Glink: The house you live in. And that is, in itself, although we try to dissuade people from thinking about a house as an investment, it's really a piece of the rocks.

Benz: Your net worth at least.

Glink: It is usually as much as 60% or more. If you then spend another $200,000, you may be over-weighted in real estate. You have to think about that. On the other hand, if you are able to generate the income--and let's say you buy a $200,000 house, you don't need a mortgage for it. Your money has been sitting in a bank account or in a CD earning maybe 1%, 2% and you are going to be able to get an 8% to 10% return on that money. Yes, you are overleveraged in real estate, but you are generating real income, and it's something that's a great hedge to a market collapse, for example. People are going to need to live somewhere and renting is on the rise, home ownership has been on the decline. Rents are rising, especially in comparison with income.

You've got a sense where you have to look and see what is available in your marketplace. Where we are seeing a lot, when I look at the markets and I talk to the economists and housing people, where we are seeing a lot of juice in the industry right now is with multifamily. Fannie Mae just announced a brand new program, I think it was Fannie, where they are going to give steeply discounted loans to developers who want to build multifamily, who want to devote for the life of the property a percentage to affordable housing. There are some still Section 8 and other kinds of benefits and perks to building affordable housing. If you are inclined to build something rather than renovate something, or even if you renovate, let's say, a small apartment building with four units, there maybe some additional tax benefits to consider that would make it a worthwhile investment for you.

There's a lot of different ways to look at these things. But let's say you don't want to actually start bricking things up and painting windows and actually screening tenants, there are ways to invest in real estate investment trusts. Those have been a little bit on the decline. You have to look at kind, whether you go with mortgage-backed one or one that's more retail-oriented, I'd be careful there.

Benz: You could buy a fund or an ETF that's devoted to REITs, too.

Glink: Correct. You absolutely can. You may actually run across somebody who is buying a small building and they are willing to sell you a share in because they are syndicating it. Or you've got a partner that you can go in with. One of our properties we actually did go in with a partner, another real estate attorney, and that's worked out just fine. I mean, we didn't think it would for a while but then it did. The one thing I would caution people is that this is not for the faint-hearted, and it's not something to be entered in casually. Take your time and do your research.

Benz: One universal rule that applies to investing is that you don't want to be buying at a really point in the market and I think …

Glink: Do you know when that is?

Benz: I don't. But the question is, we've seen some markets really hit up in certain parts of the country. I know that it's sort of human nature to think, this is a good time to buy, after we've seen a lot of price appreciation. How can you protect yourself against buying at a high point?

Glink: One of the things that I learned a long time ago from studying the marketplace is you never really want to lead a neighborhood. By that, I mean you look at a neighborhood and you look at who is living in that neighborhood and who is attracted to that neighborhood. If you see houses that are priced above what those people can afford even with today's low interest rates, that neighborhood is going to come down in price, or it's just going to stay flat until the market sort of catches up. You have to be really--that's the level of detail and research I want you to do. You have to talk to agents and see what properties are going for in terms of renting. You have to really understand what the costs are going to be to fix it up.

And so, when you are making that investment, this is truly a place where it's not enough to check the box, I think it's going to work. You can lose a lot of money fast investing in real estate if you are not careful. And yes, property prices have risen very quickly. Personally, I would never invest in Palo Alto, California. I mean, a teardown is now $2 million, but I sure wish I had bought 10 years ago, like our friends, because their house has tripled in price in seven years, and a nice little one-bedroom house across the street is selling for $2.5 million. That to me is beyond comprehension. If you are in a situation where you don't understand what the numbers look like and you can't possibly imagine it, step away, there's lots of other places to go.

I would recommend you might want to look at a HUD home. HUD homes are, of course, FHA foreclosures. People go, things happen. But at HUDHomeStore.com, which is the federal government's website for HUD homes, you can find HUD homes that are in neighborhoods across the country that you maybe able to get for a very favorable price and then be able to find people who want to buy those HUD homes or rent those HUD homes from you and that might be a good place to start.

Benz: One other question is, we've seen mortgage rates lift a little bit over the past year. They are still pretty low by historic norms. How should that factor into the calculus, if at all?

Glink: Again, what is it going to cost you to buy the property, finance the property, fix up the property, find the tenant, pay the agent, and then what are you going to take at the end of whatever tax deductions are left.

Benz: Does it need to be cash flow positive on day one, year one of my …

Glink: If it could be, good for you. I would love that. But my …

Benz: Not necessarily the case.

Glink: No. Mine haven't been. On the two that we have left now, on a pre-tax basis, one is now profitable, but we've had it for almost 20 years. That mortgage is way paid down. We are clearing a really good amount of money every month on that. It wasn't cash flow positive to start. The other one has sort of been borderline. Some years it has been, some years not. When we sell it, we'll have a huge deduction and recapture we'll have to work on. But we'll end up making money from that. The message here is, this is not a quick thing. All the HGTV shows that you watch, they all seem to have happy endings; I'm here to tell you that when it comes to investing in real estate, if you wanted to work out, time is your friend.

Benz: Ilyce, always great to get your insights. Thank you so much for being here.

Glink: It's been fun.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.