Is Renting Really Just “Throwing Your Money Away”?

If you’ve ever bought a house — or explored the idea of it — you’ve probably heard the phrase, “rent is just throwing your money away.” In fact, there’s a good chance that either your real estate agent or loan officer was the one who said it.

It makes sense, from a distance: when you own a house, you have equity.  It’s an investment. Renting, on the other hand, is just money in exchange for being able to live in a certain place for a certain period of time.

So with that in mind, shouldn’t you try to own a house as soon as you can afford to?

Not so fast, grasshopper.

For most people, at some point in their life, it does make sense to own a home.  

But not necessarily from an investment point of view (though that’s part of it), but rather from an emotional point of view.  Emotional and non-tangible things factor into real estate and homeownership far more than “experts” give them credit. 

When considering buying a home, you need to do a bit of soul-searching and ask yourself “why.”  If the answer is, “because I’ll miss out on a better deal if I don’t” then you need to do some reevaluating.

Here are several things to consider each time you hear the phrase “rent is just throwing your money away”:

 What really matters is investing your money…not whether you rent or own.

The concept of “own, don’t rent” is a red herring.

People easily misunderstand it and think that owning a home is the best or perhaps even only type of investment they can or should make.

That is simply not true.

Think about it: the S&P 500 typically has a return rate of 10-11% per year.  Compared to that, real estate is around 8%.  

Even if we highball that estimate and put real estate at 10% a year (as is the case with a really good investment), remember that stocks are a liquid asset, unlike real estate.  You can cash out your investment in the stock market at any time.  With a house, it takes time to find a buyer and finalize the process.

“Okay, but I don’t plan to sell my house.  I just don’t want to deal with inflation.”

That’s one good reason for owning a home, but again, you have to consider it in the context of all the other factors.  For example…

Consider the hidden costs of housing.

Several years ago, my wife and I were going to live in a certain area of Florida, temporarily.  We decided to buy instead of rent.

By the time we sold the house and moved, we did the calculations and realized our “investment” had been no different than if we had just decided to rent.  In fact, it had been more of a hassle.

How?

By the time we factored in closing costs, paying our agent, taxes, and the interest we paid on the mortgage, we realized we had paid the same as if we had just rented.

Here are the costs to owning a home that many buyers overlook:

  • Property taxes
  • Realtor fees
  • Closing costs
  • Maintenance (think roof, plumbing, AC…all the things a landlord takes care of when you rent)
  • PMI (Private Mortgage Insurance) — for a down payment less than 20%
  • Interest (it takes time to pay interest off the mortgage and get down to the principal/build equity)
  • HOA (if applicable)

These expenses add up fast and can take the glamor out of homeownership quickly. For a house purchase to make sense, financially, you need to live there at least five years — ideally longer.  

When you invest in the stock market you also need to hold onto your stocks for about that long to see stable returns…but at least with stocks, you can live your day-to-day life however you want.  With a house, you are committing to live in the same place, in the same structure, for a relatively long period of time.

This leads to an important question you should ask yourself:

What are my reasons for buying?”

Buying a house is a very emotional process.

That’s not a bad thing.  There are good emotional reasons and bad emotional reasons for buying a house.

Examples of good emotional reasons:

  • You want to stay in the same area as your parents/extended family
  • You want a place to live that’s secure for raising a family
  • You are a homebody, enjoy having space and want a secure place to stay put

Examples of bad emotional reasons:

  • Fear: “If I don’t buy a house now, the market will only go up”
  • You assume that you need to own a house to look and feel successful in life
  • Expectation from family, peers, society, etc.

Have an honest conversation with yourself (and partner/family, if they are involved) and ask what the emotional factors driving you are.

What about logical factors?

As we explored earlier, buying a house can be a great investment if you are able to comfortably afford all the costs that come with it.

Should you buy a house if you can afford it?  Maybe not if your dream life involves investing in the stock market and traveling around the world slowly.  Owning a house is not a “one size fits all” lifestyle hack to happiness.  

But if you can comfortably afford a house, plan to live there a while so you build equity, and have good emotional reasons for doing so then buying a house is the way to go.

Just remember to…

Be especially careful in today’s market.

 Unless you find an opportunity that you can afford without stretching, that’s not overvalued, I would exercise caution right now with buying.

The current housing market is in a great deal of flux right now.  While the market certainly never stays the same, this is an unprecedented time in many ways with many strange and unusual factors at play. 

While I certainly don’t expect a “crash” like we saw back in 2008, I also don’t believe the current market growth is sustainable.  A market in which people are actively competing with each other to buy property sight unseen, waiving inspection fees and bidding well over asking price is not “normal.”

If you find a truly great deal that you can afford during this time, by all means go for it.  There’s never a bad time to buy if you find the right deal.

But if you are afraid of “missing out” on affording a house, if you are stretching to afford one, if you are hoping to find something before “all the good houses are gone” — not unlike the rush on toilet paper we saw at the beginning of the pandemic — then you are letting negative emotions drive your decisions.  And that’s never a good thing.

In summary:

For most Americans, the “American Dream” includes owning a home.  Owning a home, however, is not living the dream if you are house-rich and cash-poor. 

Last I checked, the original American Dream was “life, liberty and pursuit of happiness.”  You’re not going to feel very free or very happy being stuck with a home you’re struggling to afford or no longer enjoy.

However, you will be quite happy if you love your home, plan to live in it for a while, and can comfortably afford the monthly mortgage.

Ask yourself these questions and it’ll be much harder for you to go astray:

  • Is a house the only way I want to invest my money?
  • Do I plan to stay in the same place for a while?
  • Why do I want to be a homeowner? What are the emotional factors motivating my decision?
  • Have I considered all the extra/hidden costs of housing? 
  • Will I be able to afford the monthly mortgage without stretching myself?

And finally, remember:

  •  do not let FOMO (Fear of Missing Out) ever affect any decision in your life, especially one as big as purchasing a house.
  • The important thing is that you invest your money.  You can do this in other ways besides buying a house.
  • There is no “expiration date” for finding your ideal home. As long as you do your due diligence you’ll get there.

5 Books to Help You Get Started with Investing

No matter how long you’ve studied and practiced making good investments, it’s a good idea to keep reading new books to expand your knowledge base.

While the books I reference in this article are specifically aimed at newcomers to investing, just about anyone can benefit from reading them – especially if it’s your first time doing so.

A short explanation first:

These books I’m sharing aren’t about real estate per se. They cover the fundamentals of understanding and managing finances, managing your time and other resources, adjusting your mindset about money and making sound investments to grow wealth.

Before you delve into the specifics of the real estate world it’s necessary that you have a grasp on the broader principles of money and investment. I didn’t know much about real estate when I got started, but luckily, I read and listened to some wise financial authorities and that equipped me with the principles of how to make good investments. 

Going forward, it was much easier for me to understand how to make good real estate investment decisions.  In other words: start with the basics, and then the specifics will be much easier to master.

Here are 5 of the most formative and helpful books I read in my earlier years as a real estate investor. Though some of them have been around a while, they are full of timeless wisdom and practical knowledge.

1. Financial Fundamentals, by Larry Burkett

Before there was Dave Ramsey, there was Larry Burkett. Burkett was a big influencer during the 80’s and 90’s; while his books are usually flavored with a Christian perspective, they teach common sense concepts that everyone can benefit from.

From Burkett I learned the basics of budgeting and money managing – two concepts that you really need to learn before moving onto anything else. 

2. The Millionaire Next Door, by Thomas J. Stanley and William D. Danko

This one was a huge mindset-changer for me.

This book teaches you the difference between how society presents millionaires, and what millionaires actually look like.  The reality is surprisingly different. From this book I learned what sort of mentality I needed to cultivate if I wanted to become a millionaire.

Spoiler alert: millionaires usually don’t drive fancy cars and spend their money on “stuff”.  The guy you see driving an old pick-up is just as likely (if not more) to be a millionaire than the guy driving a brand-new Mercedes.

3. Rich Dad, Poor Dad, by Robert Kiyosaki

This is another mindset-changing book.  One of Kiyosaki’s core principles is understanding the difference between an asset and a liability – between things that add value and things that lose value.

It helped me understand what types of things I should be spending money on if I wanted wealth in the long-term.

4. EntreLeadership, by Dave Ramsey

This is a great read for understanding general business principles in addition to how to be a great leader.  In particular, it taught me the importance of social skills and relationships. 

After over twenty years in the real estate world, I know from experience how crucial people skills are. It’s also been my experience that people who go into investing (including real estate investing) don’t realize just how important the social aspect of a business is.  For that reason alone, this book is worth reading.

5. The E-Myth, by Michael Gerber

The big “ah-hah” moment with this book for me was understanding how to leverage processes and procedures, and time (both your own and other people’s) in order to scale your business.  Growing a business requires a lot of moving parts, so the key is to do it as efficiently as possible.  This book shows you how to do that.

Honorable Mentions

There are a number of other great reads out there that are worth pursuing.  These books will continue to deepen your understanding of sound investing and more broadly, a mindset of discipline and success:

Think and Grow Rich, by Napoleon Hill

The Richest Man in Babylon, by George S Clason

The Seven Habits of Highly Effective People, Stephen Covey

Money: Master the Game, by Tony Robbins

In addition to these resources, I highly recommend reading books and content from Robert G Allen, a big-time financial and investment influencer.  Start with his website, www.robertallen.com

The Moratorium on Evictions: What You Can Do as a Landlord

Since the nationwide moratorium on evictions was established last year, things have been topsy-turvy for a lot of landlords — especially ones who rely on their rental income to support themselves.

Recently the Supreme Court struck down extending the moratorium, but certain states continue to have their own ban on evictions. It’s definitely a frustrating time to be a landlord, especially if you have not yet been able to receive federal aid, but you have a few options.

  1. Do your research

Real estate is local — that includes laws about evictions and rental property.  Certain states are more “tenant-friendly,” while other states are more “landlord-friendly.” When searching the Internet for information, keep your searches focused on your state.

Here is a handy link that serves as a quick reference for what the moratorium situation is, state by state: https://www.nolo.com/evictions-ban

  1. Get help from an attorney

Because laws surrounding eviction can be complicated, especially in these unprecedented times, it’s a good idea to get the help of an attorney.  This is especially true if you are currently dealing with unpaid rent and/or difficult tenant behavior as a result of the moratorium (some tenants, unfortunately, have taken advantage of the fact they can’t be evicted for failure to pay rent).

If your tenant has violated your lease in respects other than failing to pay rent and is uncooperative, there may still be a legal road to eviction. In this worst-case scenario, an attorney can help you navigate the details.

  1. Look into your local apartment owner’s association, or real estate investment groups

These organizations will have the most relevant and up-to-date resources for you and will help you to know what your options are.  Being part of an organization also means feeling supported, and less isolated. 

  1. Don’t go to an eviction court without an attorney

In normal times the eviction process, in most places, is fairly straightforward and doesn’t require the help of an attorney while in court.

Since these are not normal times, the wisest thing to do if you are able to/wish to process an eviction is to be sure you have an attorney with you when you go to court. The additional expense is worth mitigating the potential headache you could face.

  1. Look into non-profit rental assistance programs for your tenants

 In an ideal situation, your tenant is able to stay while you are still able to receive compensation for rent. This arrangement benefits both parties and provides the most peace of mind.

Unfortunately, the recent federal aid that’s been intended to help with rental assistance has been slow to roll out, and the process has been both bureaucratic and complicated. In the meantime, it may make sense to instead look into smaller, non-profit programs to help your tenants qualify for rental assistance.

Not every tenant will be motivated or able to qualify, but ideally most will — especially with a bit of initial guidance on your end.  Good communication and trust are vital between landlord and tenant, and this includes giving resources to your tenant wherever possible.

Starting looking for opportunities by searching your zip code here: https://www.rentassistance.us/.

 Conclusion

No one foresaw the COVID-19 pandemic, nor the rippling economic consequences. Part of being a real estate investor includes the risk that events such as this may occur.

It also involves being prepared and taking advantage of any available resources. With any luck, the tide will turn before too long and you will be able to continue maintaining your real estate investments.

How to Choose Good Tenants

Real estate is a people business. 

As long as you are buying, selling or renting properties you will continually meet and interface with a wide variety of people, from bankers and attorneys to realtors — to tenants.

The last one is for many people, the trickiest category to deal with. A well-behaved and responsible tenant makes your real estate life fairly easy, but what about those nightmare stories you’ve heard about tenants who fail to pay their rent and trash the place when they’re done?

First of all, remember, there is no reward without risk.  Furthermore, greater rewards come with greater risks.  This is true for any type of investment. 

One of the risks of real estate investment is accepting a tenant who just might fail to uphold the terms of the lease, whether it be failure to pay rent or violating certain rules. This is never a fun situation but once you acknowledge that the occasional difficult tenant is part of the package it’s easier to take it in stride.

Still, there’s a number of things you can do to carefully vet the people who reside on your property.  These measures break down into roughly two categories:

  1. Objective criteria (personal minimums)
  1. More subjective indicators (behavior, impression)

Objective Criteria

In flight school there is a term pilots use, “personal minimums.”  This refers to a bare minimum set of conditions the pilot needs in order to operate the aircraft safely.  

I’ve found this principle also works beautifully when it comes to renting real estate.  For both your and your future tenant’s sake, it’s important to establish a set of personal minimums upfront.

Just as you wouldn’t want a pilot who had too few hours in training to operate a commercial flight, you wouldn’t want a tenant to rent from you if their monthly paycheck is too low compared to the rent you charge. In either case you and the other people involved are taking very unnecessary risks.

A few logical criteria will go a long way in making sure you and a prospective tenant are the right match. Here are some examples of personal minimums to have:

Credit scores

Credit scores aren’t everything, but they are usually a pretty good indicator of whether a tenant is responsible with money (and honoring their obligations).  If their credit score is not the greatest there may be a valid reason, but be willing to dig deeper and find out why.

Income

A tenant can’t pay rent if their income is insufficient. Make sure that their monthly income is at least 2x but ideally 3x the amount of the rent they will owe each month. This piece of criteria accounts for the other expenses in their lives, including unexpected ones.

Security Deposits

Requiring a certain amount of money that is not refundable until the tenant reaches the end of their lease agreement helps ensure that the tenant is responsible and forward-thinking.

This amount shouldn’t be so high that it discourages honest prospective tenants, but it should be enough of a requirement for them to commit to the lease terms. In the case they still fail to uphold the terms of the lease, the security deposit amount will help to offset your loss.

Recommendation From Former Landlord

Social proof is a powerful thing. A prospective tenant who hesitates to give you the contact information of their former residences is usually a red flag. Be sure to ask for addresses and phone numbers and make contact with a prospective tenant’s former property manager, landlord or employer.

Keep in mind that these personal minimums, while very helpful, are not a guarantee. And while nothing is a guarantee, you can minimize your risk by paying attention to any signs the prospective tenant may be giving off during the interview process.

More Subjective Indicators  

Your personal interactions with prospective tenants offer you a wealth of clues about their character and modus operandi.  These indicators are more subjective, but should be taken into account along with everything else. Body language, attitude and other behavior are important factors when getting to know a person.

Was the tenant on time for their interview with you? If they needed to reschedule, did they let you know sufficiently in advance?  Did they do everything they promised to, such as returning your calls and filling out the necessary paperwork?

Behaviors like these from a prospective tenant can give you a taste of what it might be like to have them as an actual tenant.

Pay attention to what they tell you about themselves. Does the story they tell you add up? Are they straightforward and easy-going or do they act cagey when you ask them questions?

A pattern I’ve noticed over the years is that many less-reliable tenants are often overly eager to move into a new place.  This is because they have burned their bridges and need to find another option as soon as possible.  A good tenant should be excited to move in, but not in a rush.

On the other hand, it could also be a red flag if the prospective tenant acts blase or lackadaisical about moving in.  Signing a rent agreement is a big commitment, time-wise and money-wise, for all involved.  For this reason you don’t want anyone moving in who does not treat the process with the consideration it requires.

Each person and each encounter will differ in some unique way, so ultimately it’s up to you to listen to your gut and decide whether you and the prospective tenant will be a good match.

Final Thoughts

After doing your best to choose the right tenant, always be prepared for the unexpected.  People are idiosyncratic and unique.  You may have a few weird experiences, but they will offer valuable lessons and in many cases storytelling fodder later on down the road.

Remember that your tenant, once you have drawn up a lease with them, is in a sense your partner. You have an agreement that goes both ways, and any serious drama that comes into their life could well end up affecting you.

For this reason, it’s best to never lower your standards — your personal minimums.  The risk just isn’t worth it.

At the same time, be sure to treat everyone you come across with grace and respect, and be sure to be a good communicator as well.  As you do so you will be more likely to attract and keep the kind of tenants you want, creating a win-win situation for both parties.

How to Deal with Evictions (and Avoid Them in the First Place)

If you are a real estate investor, the odds are that you’ll be renting to tenants at some point.

And if you’re renting to tenants, at some point you will need to file an eviction. It’s not a matter of if — it’s a matter of when.

Every opportunity comes with its downsides.  For real estate investors, dealing with evictions is an unfortunate reality.  But, there are things you can do to make them less painful (for both you and the tenant) as well as things you can do to avoid them from happening in the first place.

  1. Be kind, civil and respectful

The eviction process has evolved over time to be a civil way of resolving uncorrected tenant violations.  It’s a process that allows time for the tenant to either appeal or correct their violation.  There’s no need for you to get “tough” and “take things into your own hands.”

In fact, one of the nice things about living in a society that upholds laws is that you are technically not the one who’s making the final decision — it’s the legal system that does. 

A simple, “I’m sorry, but it’s important that we follow the due process of the law” is going to be far more effective when explaining things to your tenant than a shouting lecture. In fact, a tenant is far more likely to correct his or her error if you are pleasant and respectful rather than angry. Even in the event that you do have to have to evict a tenant, you’ll feel better throughout the process if you keep a positive attitude as much as possible.

Remember also that eviction laws vary by region.  Be aware of what those laws are and never overstep them.

  1. Considering giving the tenant a chance to “opt out” first

In many cases, I’ve been able to avoid the eviction process altogether by coming to terms with the tenant first.

One time I had a couple of young guys renting an apartment unit who I (and the police) discovered had been involved with some illegal matters. After the charges were pressed I sat down with them and asked if I could help them find a better place to live.  They quickly agreed to move out as soon as possible.

In cases like these, you can have an “opt-out” agreement prepared that they can sign, relieving them of their obligations in return for leaving by a certain date (the sooner, the better). This way there is “no harm, no foul” and neither of you has to go through the drawn-out legal process.

  1. Make sure you have a good lease written up 

There’s only so much you can do about a tenant you’ve already let in who you have to evict — but when it comes to avoiding that problem, there’s a lot you can do upfront.

I always recommend finding a good attorney to help you write up a lease.  Think carefully about everything you want to go into the lease, and be sure that any new tenant understands and has read it thoroughly before signing.  A well-written lease will make the eviction process easier later on since you will have it as a continual reference.

You may ask: do I need an attorney with every eviction proceeding?  Not necessarily — it depends again on state/local laws.  It’s always a good idea to have one in your contacts list, though, depending on what situations you may find yourself in at some point in time.

  1. Have a solid system in place for pre-screening tenants

Prospective tenants may be annoyed by the need for credit checks and proof of income/employment, but there’s a vital reason you need these criteria when you select a tenant.

A proof of income is not a 100% guarantee your tenant will pay the rent every time, but it’s the one of the most accurate metrics you can use.  I recommend requiring that tenants earn 3x (monthly) the amount of the rent — this leaves a cushion for them with other expenses, including the unexpected.  

Credit checks are not solid proof of responsibility, either, but they are still a good indicator.  If your tenant has had a dip in their credit, be sure to find out the reason. Make sure they are doing their best to build their credit back up.

Finally, a list of references is always good to have.  Being able to talk to an employer or former landlord should help you get a real feel for the level of responsibility in your prospective tenant.

What about “second chances”…?

“Everyone deserves a second chance” is a refrain we’ve all heard many times. You may wonder how this applies to evicting a tenant.  Should you decide to give some tenants a second chance, based on their situation and your “gut feel”?

The problem with this approach is that it quickly becomes inconsistent. How do you know for sure that this person over here deserves another chance, while the other person over there does not?

The legal process of eviction usually has second chances built right into it.  Typically tenants have at least a month and sometimes multiple months from the time you file for eviction until the time the law enforcement comes to escort them away. During this time, the tenant has the continual opportunity, at any point, to correct their violation.

Evictions are not a fun topic, and these days they can be downright controversial.  However, remember that they are a part of the legal system, and at least in theory the laws are designed to be fair to both tenant and owner. They are a “last resort” after doing everything you can do on your part to remind, warn and implore your tenant. 

Finally, having a good vetting system in place ensures that you will have to do far fewer evictions. Hold to your standards, and both your and your tenants will be happier for it.

Bubble or “New Norm”? Some Thoughts on the (Near) Future Real Estate Market

Start typing in the Google search bar “Is the real estate market in a bubble right now?” and you’ll quickly see that thousands of other people are asking the same question.

No one knows what will happen, but it’s human nature to keep hoping for an answer.

And since no one has an answer, the next best thing is a well-educated guess.

And the best-educated guesses about the real estate market are the most open-ended ones.

In other words: it depends. It depends on several things, actually.

Before I go into what those things are, I think it’s important to mention that the real estate market is still in a state of flux right now. Come back in a month and I might have a different response.

There are several drivers behind the sky-high demand in the current market. These include low interest rates, immigration patterns, demographics, supply chains, and inventory.

For each of these, there is more than one possible scenario.

  1. Interest Rates

This is probably the most obvious driver. Plenty of prospective homeowners feel that now is the time to buy since interest rates have hit record lows.

If interest rates continue to stay low, we will most likely see continued demand for homes — leading to prices remaining high.

However, inflation tends to be the consequence of policies and other artificial measures to keep interest rates low. If inflation becomes more serious, interest rates will inevitably rise, leading to a cooling off of the market.

Also consider that even if interest rates remain low, at some point real estate prices will hit some kind of ceiling. The higher prices go, the fewer buyers there will be out there who can afford those prices, even at an “affordable” interest rate.

2. Immigration Patterns

This is one of the most interesting factors at play with today’s real estate market.

The pandemic of 2020 launched what was essentially a nationwide game of musical chairs: people from cities (and suburbs) left their homes to move to the suburbs and even rural areas. Many of these people moved out of state. The novelty of being a homeowner and living somewhere else, thanks to being able to work from home, became a huge motivator.

The question is, will these recent immigration patterns remain fixed? Now that the pandemic is mainly on the retreat in this country, employers are starting to require their employees to spend more time at work in person.

People will continue moving to hotspots like Florida and Texas for the time being, but it’s also very possible that there will be a tapering off of immigration overall, once the FOMO and novelty of living elsewhere/working from home begin to wear off.

We won’t know for sure either way how the game will end until the music stops.

3. Demographics

Millennials took a lot of heat for a number of years for being okay with living in their parents’ basements.

Now it appears that many Millennials are ready to start forming their own households and clearly, they are doing so. They are a key demographic in the current demand for homes.

Whether enough of them will find homes for the time being (or content themselves with waiting) will be a factor, most likely, in where home prices are at.

An exacerbating factor, arguably, are Baby Boomers who are not ready or willing to sell their homes yet. Traditionally the older generations begin to move on to retirement homes to make room for the younger. But as long as Boomers continue to prefer living in their houses we may see a continued housing shortage, leading to continued demand.

4. Supply Chains

This is one that I see being rectified over the next year or so. Because the pandemic came on so suddenly (not to mention unexpectedly), suppliers (lumber, appliances, etc.) were simply not able to keep up with demand.

Of course, there have been some complicating factors: a shortage of employees in blue-collar industries has made it harder for manufacturers to step up their output, for one thing.

It may take longer or shorter for supply chains to catch up with demand, but unless something untoward happens, I see this as happening at some point before too long.

5. Inventory

At the end of this month, the federal moratorium on evictions will be lifted. While a few states will continue to use state-wide measures to prolong the moratorium, we should see a number of property evictions happening at the beginning of next month.

As a result, property owners who are tired of being landlords will be ready to sell.

The main question here is: how many properties will return to the market when this happens? Will it be a flood or more of a trickle?

Besides the moratorium, there are a few other ways that inventory could increase. People who were previously too nervous about putting their homes on the market due to the pandemic and uncertainty of the times may now feel more emboldened.

Some older folks may also be ready to make the jump to a retirement community now that they don’t have to worry about “lockdown” and not being able to leave — although as I said earlier, more and more people seem to be choosing to stay put, even as they age. Mortality and health ultimately will decide where they (and their homes) go, and it’s still too early to tell.

Bottom Line

All of these drivers are currently influencing the real estate market. There is also no question that things will continue to change: there will be evictions after moratoriums are lifted, interest rates will fluctuate, and so on.

The real question is, which of these things will be the main driver for determining the near-future real estate market? I don’t necessarily think we’re in a bubble, but things never stay static either.

Which of these drivers do you think is the biggest?

And are there any other important drivers I may have overlooked? Let me know in the comments below!

Commercial Vs. Residential Real Estate: What Are the Big Differences?

I was recently talking to a friend who said this about commercial real estate: 

“It’s not that different from residential.  It’s just more numbers and zeroes.”

For the most part, I agree.  Both commercial and residential are similar when it comes to the fundamentals.  Both involve careful cost-benefit benefit analyses.  Both involve tenants, taxes and leveraging debt.  

There are some big differences, though, as well. 

Just like with most things out there, both have their pros and cons.  (I love and invest in both residential and commercial, for the record).

Here’s a quick preview of some of the key differences:

Lease structure

Valuation (price and ROI)

Transaction process

Sophistication/level of education required

Before diving into the differences, though, some quick semantics first:

“Residential” properties are recognizable to almost all of us in the forms of houses and other buildings people dwell in.

“Commercial”, on the other hand, takes a wide variety of forms — anywhere from business offices to restaurants to shopping complexes to storage units.  

On a technical level, a residential building (like an apartment complex) can be considered a “commercial” property from the perspective of a lender when it comes to certain finer points.

But to keep things simple, in this article when I use the word “commercial” I’ll be referring to properties with business operations.

#1 Lease Structure 

When you are renting out a house or apartment unit to a tenant, the lease tends to be year-to-year; maybe a little longer, maybe a little shorter.

Commercial real estate, on the other hand, usually involves longer leases — upwards of ten or even fifteen tears. The upside of this is pretty obvious. It’s great to have a tenant who most likely won’t be going anywhere anytime soon.

The downside is, when you eventually do lose a tenant, the space can be harder to fill.  Side note: for this reason, if you invest in commercial real estate it is especially important to have a strong network.

In residential real estate leases, the owner is generally responsible for maintenance and care of the building. When it comes to commercial real estate, this typically isn’t the case — instead, the business owner is responsible for maintenance in addition to paying rent.

This is certainly a positive aspect of commercial real estate for investors who can afford it.  Something to keep in mind, though, is that the process of structuring the lease may be more complex and even require the help of an attorney.

#2 Valuation 

This is one of the most important differences between residential and commercial real estate.

With residential real estate, you are comparing properties to each other to get a feel for what a “good deal” is.  When you buy a property, you’re often hoping to increase its value within a short time frame (anywhere from weeks to a few years).

On the other hand, commercial real estate values tend to be more stable and fluctuate less.  When you buy a commercial property, you aren’t focused on “profit” so much as you are “return on investment.”  Each commercial property has a different value based on its individual qualities, with a certain % of return you can expect if you decide to purchase it.

In other words, it’s a more stable and fixed investment.  You’re not likely to suddenly see an increase in your property’s value but you’re also not likely to see a sudden drop.  

 #3 Transaction  

When you’re buying a residential property like a single family home, there’s a good chance that at some point you will be dealing with either an end-use buyer or seller.  These people see the transaction as more than just money changing hands — it’s an emotional process for them involving a home, with values that aren’t always as tangible.

With commercial real estate the mood of the transaction process is different — generally speaking, it’s “all business.”  Humans are emotional, of course, so that doesn’t mean that commercial real estate transactions are robotic and flawless, but there definitely is a different dynamic at play.

#4 Education

By now it’s pretty clear that commercial real estate is more complex than residential.  There is more paperwork involved and there is more jargon involved.  

If you already have experience buying or selling residential real estate — even if it’s just your own home — that’s great.  That’s a good start to your education.  In order to have a good handle on investing in commercial real estate you will need to further your education.  A great way to do this is to find a mentor: someone who has successfully invested in commercial real estate and is willing to spend a little of their time with you explaining what they know and answering questions.

In summary:

  • Commercial real estate is often more “stable” than residential, but it also requires more education to understand and maneuver
  • The lease structures for the two are very different.  Residential leases are shorter, which means more turnover but vacancies are easier to fill.  Commercial leases are generally longer-term and more stable, but vacancies can take a while to fill
  • Commercial real estate is focused on ROI.  You generally know what % of a return you can expect; it’s less risky
  • The transaction process with commercial real estate tends to be less emotional but more complex than with residential
  • Commercial real estate has a higher “barrier to entry” than residential, due to generally being more costly as well as more specialized and complex

To this I will add:

Most people, for obvious reasons, start out in residential real estate and work their way “up” to commercial real estate. The buying and selling process for a single-family home is more familiar (and usually more affordable) to most of us than the process of buying and selling a business complex.  It makes sense to start smaller and to start with what you know.

Some people choose to only focus on one or the other.  I love and invest in both, and there’s no reason you can’t too.  In fact, investing in both is a great balance. The key with commercial real estate is furthering your education to get your foot in the door.

Should I Buy or Wait? A Closer Look at the “Post”-Pandemic Market

Image by Harry Strauss from Pixabay

If there’s one thing that most people — investors and non-investors alike — agree on, it’s that no one saw the pandemic of 2020 coming.

Since then, we’ve seen a lot of ups and downs in the world…in the real estate market, though, it’s been mostly “up.”  This is good news for those who simply want to sell.  It’s a bit trickier if you’re an investor.

The million-dollar question everyone is Googling right now is: “What’s going to happen to the real estate market?”

Tied to that is the question of: “Should I buy now or wait?”

Unfortunately, I do not happen to own a Magic 8-Ball (if that changes, though, I will be sure to let you know). What I am able to offer you are some possible scenarios, tied to several key factors.

These key factors are:

Interest rates

Forbearance/foreclosures of mortgages and homes

Supply and prices of lumber and other goods

Comfort level of sellers

Note: these are not the only factors involved — just the ones that I find are the most relevant. The topic of the pandemic and how it has affected the economy is obviously both broad and disputed.

Let’s take a look at each of these and see what the possible scenarios are. In some scenarios, buying now may be a better choice, while the smarter idea may be to wait in other scenarios.

It’s hard to say for sure which scenario is more likely, but knowing what the possibilities are will help you to look for the signs and be ready to make a move either way.

Interest rates

This has been one of the biggest drivers for rising demand in the real estate market. Who wouldn’t want to lock in a 15 or 30-year-loan at less than 3%?

If rates continue to stay low for a good while, there isn’t necessarily a reason to rush. On the other hand, if inflation continues to grow, we might see rates go back up before too long.

Does that mean you should try to “lock in” a loan with a low interest rate now, before it’s “too late”?

If you’re talking about a fixed-rate mortgage and you are able to find something within your price range, that may indeed be a good move. The trickiest part here is finding something within your price range, especially since the continual demand for properties has driven prices upwards to the point that a property in today’s market with a lower interest rate does not always mean a better “deal.”  

Also, if you go with an adjustable-rate loan there is always the risk of being hurt by rising interest rates later. So while lower interest rates are a good thing in and of themselves, a good deal of homework should still be involved with any acquisition you make.

Forbearance/foreclosures of mortgages and homes

When COVID hit, many homeowners were given forbearance to pay their mortgage to prevent mass foreclosures from happening and causing another recession.

Some of the thinking with this was: once the economy “reopens”, people will be able to go back to paying their mortgages.

Will that be the case once the moratoriums are lifted nationwide in a couple of months from now, or will homeowners still be empty-handed and forced to foreclose?  Certainly, there will be cases of both, but which situation will be the majority?

If the latter, then we can expect to see a sudden influx of homes on the market when that happens.  However, depending on how high demand continues to stay (or even rise), we may not necessarily see much of a drop in home prices. (Also, it will depend on where those interest rates are at).

Supply and prices of lumber and other goods

The sky-high price of lumber was one of the most bizarre consequences of the pandemic, and yet in hindsight, it does make sense.

Homeowners with time and stimulus money on their hands decided to do home improvement projects — including expansion.  Meanwhile, demand for houses also meant a demand for the materials for building houses.

Part of what was so crazy was just how high the lumber prices went.

A similar situation is happening with other materials and appliances needed for construction. Builders are struggling to finish their projects on time, and the delays are adding to the problem of low inventory.

Surely these shortages have to end sometime, right?  Of course, but as always, the question is when

My best guess is that we’ll see things settle quite a bit within the next twelve months or so as suppliers get a better handle on stocking items and adjusting to demand, while demand itself may drop a bit during the cooler months when construction is more difficult in the colder parts of the country.

Comfort level of sellers

During the peak of the pandemic and ever since then, many sellers have been hesitant to put their homes on the market.  Part of this is due to fear they won’t be able to find an affordable deal somewhere else, but part of it is also fear related to COVID — specifically, engaging in social interactions with buyers and other people involved in the selling process.

Keep in mind, too, that plenty of older people who may have planned to move into a retirement community also put those plans on hold once the pandemic hit.

Now that things are continuing to revert back to normal there’s a likelihood that at least some of these individuals will be ready to downsize or otherwise move on and sell their homes, adding to the supply.

One More Consideration

One other thing I should add:

Each geographical location has its own “micro-economy.” The housing market in Detroit right now is different from the one in Austin, to take an obvious example.

Whether it makes more sense to buy or wait depends on location as well as the other things we’ve mentioned.

While real estate value goes up over time, generally speaking, there are some locations where that is far truer than in others. Even though the current housing market situation we are witnessing applies to the country, generally speaking, you still need to do your homework when it comes to geographic considerations.

In particular, take stock of the economy of the area you are looking to buy in. Has there been a lot of recent growth? Is further growth sustainable? Are more people coming into the area than leaving? These are all helpful indicators.

Conclusion

All of the factors I’ve mentioned will happen in some form, sooner or later.  The big unknown here is when, and to what extent.

Will interest rates rise enough to dampen buyers’ demands within the next couple of years?  How much will moratoriums and evacuations add to supply? How many people who currently own will feel comfortable enough to sell in the next few months or years?

Because we don’t have a Magic 8-Ball to hand us the answer, the smartest thing — in my opinion — is to wait a bit and see. That doesn’t mean you should not buy in the meantime.  By all means, if you find something within your budget that has the potential for positive cash flow then buy.

But fear of a “worst-case scenario” should not be your driving motivator to make a decision. Right now the dust is still settling and it’s hard to see in which direction yet all the pieces will fall. While it can be hard to be patient, now may be a better time than ever to put those patience skills to use. 

Do your due diligence, keep an eye on changes in the market, have a positive attitude, and you will find the right deal for you, at the right time.

What is a “Good Deal”? Here’s Some Simple Math

Image by Shutterbug75 from Pixabay

As a real estate investor you’ll need to be able to do some math to know if you’re making a good investment or not.  

But don’t worry — you don’t have to be a whiz or create an Excel file. I’m talking about the kind of math that’s easy enough to do with your phone calculator.

Over the years I’ve come up with a fairly simple formula.  Other investors have come up with it independently of me, so that tells you it’s a pretty solid one.

The formula involves 3 numbers, plus something called the 1% Rule.

The 3 numbers are…

  1. What you buy the property for
  1. What it costs to renovate it
  1. What you rent/sell the property for

This should be pretty straightforward. Of course you will need to sell the property for more than you paid, even after the cost of renovation.

If you plan to rent, this is where the 1% Rule comes in.

Here’s how the 1% rule works:

Monthly rent = 1% of total investment cost

For example: You buy a property for $100,000.  Once you figure in purchasing and renovation costs as well, the total amount of your investment is $150,000.   1% of 150,000 is $1,500.  Therefore, you need to be able to rent your property for at least $1,500 a month.

(Side note: always make sure you factor in renovations and other upfront costs, not just the price of the property itself). 

Now, does a purchase prospect have to meet the 1% Rule? Not necessarily. But it’s definitely a good, conservative rule of thumb that will act as a guard rail.

The 1% Rule gained traction back when interest rates were higher than they are now.  It may be possible for you to have a positive cash flow while pulling in less than 1% a month, but let’s put it this way: if you are able to earn 1% or more a month, you’ll have a positive cash flow and a safety cushion as well.

If the property is going to earn you less than 1% a month, it may or may not be worth pursuing. You will need to go back to the drawing board and do some “less simple” math at this point.

All good so far?

There’s actually one more step you need to add, once you’ve figured out your monthly rent payment.

The step looks like this:

Actual cash flow = ½ of your monthly rent

A lot of investors aren’t prepared for all the costs that come with owning a rental property.  These costs include things like insurance and maintenance as well as vacancies.

To have a realistic estimate of what you will actually pull in each month, make sure that you halve the amount of your anticipated monthly rent.

Sticking with our earlier example, that means that your actual cash flow each month will be $750 (half of $1,500).  

The other $750 is going towards those other expenses.  In fact, it’s a good idea as a property owner to have a “maintenance reserve” fund for exactly these types of expenses.  It’s very possible for you to have a cash flow that’s greater than half your monthly rent — just remember, that the smart thing to do is start out with an estimate that’s more conservative.

My final two cents:

Time is valuable, so don’t waste your time or efforts on a property if you’re not sure whether or not it will be worth it.

There are other properties out there (even in today’s crazy market) and good opportunities exist, if you look far enough. It may actually be wiser to sit out a certain prospect and spend your day at the beach than to rush in and buy something that doesn’t jibe with the simple math.

With both time and some good simple math calculations, you’ll find the opportunity that’s right for you.

BRRRR: The Good and the Bad

Image by Nattanan Kanchanaprat from Pixabay

Believe it or not, the popular so-called “BRRRR” method has been around long before people actually started calling it that.  It was the method I used in the beginning of my real estate career — I sort of “discovered” it along the way — and I still use it to this day.

Does that mean it’s the best and only way to invest in real estate?

Not necessarily. There are definite pluses but a few pitfalls as well. As a quick review, here’s what the acronym stands for:

Buy

Renovate (or Rehab, if you prefer)

Rent

Refinance

Repeat

In theory, it’s a process that you can use on repeat to build your wealth. The reality is a bit more complicated. You can definitely make BRRRR work for you, you just have to be smart about it.

What’s Awesome about BRRRR

You don’t need a lot of money to get started! (Remember how I said this was the method I used in my early days?  That’s exactly why).

The idea with BRRRR is that you leverage the capital you’ve put in as a down payment or other means to use on your next property, after you have refinanced.  This is what allows you to repeat the process.

Refinancing your property also allows you to find a better lender and get a better interest rate. 

BRRRR is like a very skilled game of leapfrog. You are able to leverage your first acquisition to buy your next and so forth, without (theoretically) having to sell any of your properties to make your next purchase. 

If you don’t have a lot of capital to invest upfront, but are willing to do the careful work of acquiring the right kind of properties that will allow you to refinance at a rate rate later, BRRRR may be the right method for you.

What the Drawbacks Are

Almost everything good in life comes with a catch. BRRRR is no exception to the rule.

The BRRRR method works really well, but only within certain parameters.  You need to be able to increase the value of your property enough to be able to pull off the trickiest step: refinancing.

You can quickly run into trouble with BRRRR, for example, if your appraiser decides the property isn’t worth as much as you think it should be worth. 

Increasing the value of a property is not a cut and dry, “money = value” process.  Spending $50,000 to renovate your property, in other words, does not automatically make your property worth $50,000 more.

While renovation is important, it’s just as important that you buy a property with good potential in the first place — this includes factors outside your direct control, such as the quality of the neighborhood. 

Also, removing the cash equity from your property to make your next purchase always comes with a risk.  Make sure you have added real value to your property after renovating it, otherwise you will have little to no equity left besides what you originally put into it as cash.

Some Other Things to Think About

One thing that will help you succeed with BRRRR is having a good exit strategy.  By “exit” I am referring to the “refinance” phase — the point at which you are ready to move on to your next property.

Having a good lender (especially on the back end) and having the right conversations with them ahead of time is key. 

Be sure to ask all the necessary questions, such as, “what kind of things are you looking for in the properties you refinance?” and, “how much time needs to pass between purchasing and refinancing?”  

Knowing this information ahead of time allows you to develop a strategy and a realistic timeframe.  It will help you know how to add value to your property and keep you from trying to rush into the next property too quickly.

Just like with any investment strategy, remember to focus on the 1% rule. Cash-flow is the lifeblood of real estate investing. The amount of rent you earn needs to be relative to the cost of renovations.

Conclusion

The BRRRR method is popular for a good reason. It allows investors who don’t have as much cash upfront to still invest in multiple properties and grow their wealth.

However, there are always two sides to the coin. Having less money means more risk at every stage in the process, especially with renting and refinancing. You can mitigate these risks by doing your homework, being careful about your renovation budget, and having good communication with a good lender ahead of time.