Real estate investing can appear to be overwhelmingly dominated by opinion rather than fact. Few non-institutional investors bother to collect the scarce bits of data that can truly determine whether or not that investment house in your municipality would make sense from a financial standpoint.
In fact, if everyone’s talking about it, it’s probably a terrible investment. Fundamentally, if a property is in fact an investment, it should be income producing.
Let’s look at a fictional town of Investmentville
A pleasant up-and-coming suburb outside of a major US city. You rent the house you live in, and your neighbor brags that his paid-off house appreciated by 10% over the last five years.
Because of his positive experiences, he’s thinking about putting his retirement money towards an expensive townhouse on Main Street which he plans on using as a rental property.
He suggests that you should do something similar. What do you think?
Well, it depends on the circumstances. If the stock market went up 30% over the last five years, then your neighbor should not be bragging. He would have made more had he bought shares in the S&P 500.
If we make the assumption that the Investmentville house and the stock market will continue to appreciate at the same rate (over the next five years), wouldn’t it be smarter to put the retirement money into the stock market instead?
Well, yes…sort of.
The real world is a bit more chaotic. Because the real estate market is fragmented, countless opportunities show up every day. And many of these opportunities outperform the stock market by a very wide margin. This is why the savvy investors are constantly on the lookout for these incredible deals.Smart real estate investors are a very calculating bunch. Click To Tweet
Because, remember, money has an opportunity cost. Every dollar sitting in investment A is not sitting in investment B. The only way to determine which is better, between A and B, is to do some quantitative analysis of the two.
Be scientific. Just because A feels like a good investment doesn’t necessarily make it superior to B.
Run the numbers!
Let’s assume that the interest rate in the US has been 3% for a while, and let’s assume that it will continue for the foreseeable future. It follows that if your $100,000 real estate investment has only been increasing in value by 1% per year, you’re losing money compared to the inflation rate. (For practical purposes we will assume that inflation is 4% per year).
You could have put that $100,000 into inflation-proof treasury bills instead, netting you more money over those years.
See what we mean?
It can be very difficult to properly gauge how profitable real estate is, but it’s good to be as quantitative as possible when making comparisons. Some people lose money every month, while others make enormous fortunes off of real estate investing.
The dividing line between the haves and the have-nots in real estate is top-notch quantitative analysis of the market and following a well outlined business plan.