Are Real Estate Investments Worth the Effort?
Over the past few years, I’ve flirted with the idea of investing in real estate. But the combination of my aversion to debt and the idea that real estate is too much work has kept me from taking the plunge.
A reader of the blog recently summed up my thinking in one sentence. She wrote, “I would love to participate in the real estate market, but don’t really want to become a landlord and publicly traded REITs are not ideal either since they are still stocks hence not enough of a diversifier in my opinion.”
So I reached out to my blogging friend and real estate investor Brian Davis and posed this dilemma to him. He summarized real estate investment options, from least to most effort, for those of us sitting on the fence considering whether or how to add real estate to our portfolios.
Take it away Brian….
(Disclosure: Can I Retire Yet? has no financial relationship with Brian or his company SparkRental.)
The Pros and Cons of Real Estate
Real estate comes with some impressive advantages for anyone looking to retire. From ongoing income to tax benefits, leverage, to inflation protection, investors can put their real estate investments to maximum use.
Real estate comes with its share of disadvantages too. Poor liquidity, diversification challenges, and high barriers to entry all come to mind.
But the amount of effort required ranks up there with the greatest deterrents holding would-be real estate investors back.
Related: Using Rental Properties to Create Retirement Income
Still, not all real estate investments come with the same headaches or labor requirements. Below are the most common real estate investments, ranked from least to most labor-intensive.
1. Publicly-Traded REITs
Real estate investment trusts (REITs) trade on public stock exchanges. That makes them just as liquid as stocks — and just as volatile.
You can buy and sell them instantly, and they require no work on your part. They offer one of the few truly passive real estate investments available.
Additionally, they tend to pay high dividend yields compared to most stocks. The SEC requires them to pay out at least 90% of their profits in the form of dividends each year, but that comes with a downside as well.
It’s extremely difficult for REITs to grow their portfolios and buy more properties. Which in turn means weak growth potential for most REITs.
Another downside? Because REITs trade on stock exchanges they tend to move in disturbing synchronicity with stocks. That high correlation with stock movements largely defeats the purpose of diversifying at all.
Feel free to buy some shares in publicly-traded REITs for the dividends, but don’t expect substantial diversification benefits or outsized long-term growth.
2. Private REITs
Over the last decade, another type of REIT has risen in popularity: private company REITs…. more specifically private REITs funded through real estate crowdfunding.
These funds own real estate, or lend money against real estate, just like their publicly-traded counterparts. But they fall under different SEC regulations, and aren’t required to pay out 90% of their annual profits in dividends. That leaves them more flexibility to grow their portfolios over time.
They also don’t come with the same liquidity. While you can buy them instantly, you can’t sell them on the open market. The company will typically offer to buy them back from you at a discount, if you want to sell out your shares within five years of buying.
The upside is that they don’t have the same volatility as publicly-traded REITs.
Some private REITs pay high dividends, such as Streitwise. Others, such as Fundrise, offer different funds with varying dividend yields, and still others pay no dividends and put their profits back into growing their portfolio (such as Diversifund).
Do your homework before buying shares, but these companies do offer true diversification away from stocks and bonds.
3. Crowdfunded Loans
Another type of real estate crowdfunding involves putting money toward individual loans secured by real estate.
My favorite example is GroundFloor, which lets you pick and choose the loans you want to fund. And you can put as little as $10 toward any given loan, allowing you to spread money across many loans for easy diversification.
Another advantage with platforms like these is the shorter commitment. Many, including GroundFloor, specialize in short-term loans to house flippers. These are purchase-rehab loans with high interest rates, and as soon as the property is renovated the borrower sells it and repays the loan.
Like Streitwise and Fundrise, GroundFloor allows non-accredited investors to participate. Note that many crowdfunding platforms only allow wealthy investors, for regulatory reasons.
4. Private Notes
If you personally know and trust any real estate investors, you can always invest money with them by lending them a private note.
A “note” is the legal document that a borrower signs when taking out a loan. You lend money at a set interest rate, and collect regular payments.
Some investors require a lien against the property, by having the borrower sign a deed of trust (just like mortgage lenders require). If the borrower defaults, you can foreclose on the property. Just beware that the process isn’t fast or cheap, even for investment properties.
Ultimately, private notes come down to trust. If you know a real estate investor well, and they’ve established both personal trust with you and a track record of success with their investment properties, you might feel comfortable lending them money.
I have some money invested with a couple I know, and they’ve paid me 10% interest like clockwork. It’s a completely passive investment for me, with no repairs or tenant headaches.
But don’t lend your money lightly. Make sure you feel absolutely confident that the borrower will pay you back, with regular interest payments.
5. Real Estate Syndications
Rather than lend money to real estate investors, you can partner with them on deals.
Known as real estate syndications, an experienced syndicator will find a good deal on a property, then raise money for it from a series of partners. The partners each buy a percentage of the property, proportionate to the money they invested.
Unfortunately, these tend to only be available to accredited investors. The regulatory burden is too high for syndicators to raise money from middle-class investors.
If you qualify as an accredited investor, you can research real estate syndications online, but do your homework before committing money. Look into the syndicator’s track record and experience, and aim to get to know other investors in the field to build community trust.
6. House Hacking
In the classic house hacking model, you buy a duplex to move into one unit and rent out the other. Or a triplex or fourplex — they qualify for conventional mortgage loans as well.
The rent ideally covers your mortgage payment, and hopefully your maintenance costs as well. Which means you essentially score free housing, nullifying the rent vs. buy debate entirely.
Free housing also helps allay some of the fears associated with retiring. It drops your living expenses considerably, which also means you can retire with a smaller nest egg.
For that matter, there are other ways to house hack besides buying a multifamily home. You can bring in housemates, or rent out storage space, or rent out an ADU on Airbnb. My partner Deni even hosted a foreign exchange student, and the stipend covered most of her mortgage payment!
If you ever decide to move out, you can keep the property as a rental to boot.
7. Turnkey Rental Properties
Nowadays, you can buy turnkey properties anywhere in the country with minimal effort.
These properties require no renovations by definition. They are move-in ready, or may even be occupied by tenants already. Which doesn’t mean they don’t require any effort on your part.
You need to do your due diligence on the property’s condition, the state of the neighborhood, its trajectory, what kind of people live there, and so forth. You probably need to finance it with a rental property mortgage.
If it’s vacant, you need to market it for rent, and then inspect it regularly and maintain it. Rental properties offer some unique advantages for retirement income, but the income isn’t completely passive. Even if you hire a property manager, you still need to manage the manager.
Weigh the advantages against the risks and labor, and decide if the juice is worth the squeeze.
8. Raw Land
Raw land isn’t sexy or exciting. Which is precisely why the returns tend to be higher than other real estate investments.
Even so, it takes some time and effort to learn the business of flipping land. And I do mean business.
Investing in land involves researching markets, sending out daily mailers, and learning how the legal mechanics of buying and selling raw land work. This says nothing of learning how to market and sell a niche investment like land.
This strategy can create long-term income streams, even when you flip it. Many sellers offer owner financing, which generates interest on top of their profits from selling the land itself. Once sold and financed, land can provide passive income.
If you’re interested in creating a side business that you can one day automate for strong passive income, consider learning how to invest in land.
9. Flipping Houses
Everyone understands the house flipping business model. They don’t necessarily understand all the work and risks involved.
From finding good deals to financing, from managing contractors and renovations to hassling with government inspectors, house flipping comes with a slew of risks and headaches. And, when done properly, profits.
But there’s nothing passive about flipping a house. It’s hard work, and the most successful flippers approach it as a business.
10. The BRRRR Method to Build a Rental Portfolio
The only real estate strategy that involves more work than flipping houses is the BRRRR method of real estate investing.
As an acronym it stands for buy, renovate, rent, refinance, repeat. In other words, rather than buying a fixer-upper to sell after renovating, you keep it as a rental.
The BRRRR method comes with several enormous advantages to compensate you for your efforts. First, you can score a bargain on the property as a fixer-upper, then force equity through renovations, just as with flipping. Second — and here’s where things get interesting — you can pull out part or all of your original down payment when you refinance the property.
It works because the refinance is based on the after-repair value (ARV) of the property, post-rehab. So theoretically, you can recycle the same down payment over and over, all while building a portfolio of cash-flowing properties.
Aside from all the work involved in renovations and managing rentals, it does come with a risk. All too often investors pull out every cent of forced equity that the lender allows them to, even though it thins their cash flow…. sometimes to the point of negative cash flow.
I love the BRRRR strategy, but don’t start here. Cut your teeth on turnkeys to learn how to forecast rental cash flow, how to manage tenants, how to manage property managers, and how to manage handymen and contractors before committing to major renovation projects.
Final Thoughts
Diversification into real estate can limit your exposure to bear stock markets and help with your retirement tax planning. But depending on which investment strategies you use, it can also create extra labor for you.
If you’re new to real estate investing, start with real estate crowdfunding. Buy a few shares of private REITs. Spread a little money among crowdfunded loans. Get a sense for the returns and the risks.
From there, decide how much interest you have in real estate investing as a side gig or hobby hustle. If you only want to diversify, leave it at passive investments. But if you have a passion for real estate, start experimenting with some more direct, active investments.
You may just find you enjoy it enough to quit your day job.
How have you invested in real estate? What were your experiences? What’s holding you back from investing in the future?
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[Chris Mamula used principles of traditional retirement planning, combined with creative lifestyle design, to retire from a career as a physical therapist at age 41. After poor experiences with the financial industry early in his professional life, he educated himself on investing and tax planning. After achieving financial independence, Chris began writing about wealth building, DIY investing, financial planning, early retirement, and lifestyle design at Can I Retire Yet? He is also the primary author of the book Choose FI: Your Blueprint to Financial Independence. Chris also does financial planning with individuals and couples at Abundo Wealth, a low-cost, advice-only financial planning firm with the mission of making quality financial advice available to populations for whom it was previously inaccessible. Chris has been featured on MarketWatch, Morningstar, U.S. News & World Report, and Business Insider. He has spoken at events including the Bogleheads and the American Institute of Certified Public Accountants annual conferences. Blog inquiries can be sent to chris@caniretireyet.com. Financial planning inquiries can be sent to chris@abundowealth.com]
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A rental owner needs to informed about the landlord tenant laws. During this pandemic, many small landlords were handicapped by rent suspension benefits given to tenants by the government. If the tenant refused to sign relief applications, the landlord could not receive benefits either. My husband and I sold our 2 rental properties which became cashflow losers. We are putting the small profits in a REIT instead.
Pixie,
I appreciate that feedback. Certainly real estate comes with a unique set of risks and challenges.
Best,
Chris
Hi Chris, thanks and great info for me as I now have a mix of a couple rental properties and a note to diversify my portfolio. I love real estate and am ok with the property management aspect only after several years of experience and my recent retirement gives me time to do so. As mentioned regarding rental properties you manage yourself, start small and get your feet wet. It gives you confidence. I love getting rent checks every month while watching my property equity build. It feels like such a win win.
As always thanks for your awesome timely posts, makes me feel on track!
Nancy in the mountains
Great to hear from you Nancy and glad to hear all is going well.
Cheers!
Chris
Great article on RE investing! I particularly like the “least to most” effort structure. I’ve been a landlord a couple times (15 yrs was the longest). I used a property manager. It took very little effort on my part (a requirement for me) and provided a good, tax advantaged income source. My stepdad used BRRRR for several decades and was very successful with it. But, he spent a lot of time managing the properties & contractors, which he enjoyed doing after retiring from his career.
I’ve been invested in the TIAA-Cref Real Estate Fund (QREARX), a retirement fund, for decades now. It has had one downturn (easily seen and avoided). I don’t think it has surpassed the markets but it has supplied a fine return (11+% last year)with little danger of loss and no effort.
40 years ago, my brother and I tried the ‘landlord thing’ with 5 rental homes. With few exceptions, I absolutely HATED the experience. Half of our tenants were fine, never heard from them, the other half however more than made up for them. Add in late payments, worrying about evictions, dealing with small claims court to collect rent – ufff, never EVER again. Yes, we made money on each house, but it wasn’t worth it.
10 years ago, the financial planner we used got into this segment, similar to your ‘syndicate’ model, but more open. Min investment was 50k. They paid 8%+ per annum in dividends (paid quarterly). As a partner in the LLC we received our pro-rata portion of the tax benefits and profits when the properties were sold (avg 5 years). Our IRR over time (now in the 4th LLC) has averaged 15-18%+ per annum. While the S&P has done better some of those years, I continue to invest/re-invest, with a goal of 10-15% total assets invested.
There are many firms that do this and typically buy small to medium apartment complexes. It has been a great investment for us, even during the pandemic.
Interesting Tim O. Thanks for sharing your experiences.
Chris, Thanks for your article. I am not a real estate investor beyond my own home but I heard about a company, recently, called rootstock.com, which assists non-accredited investors (I think) to buy single family rental properties. It seems like an accessible twist on your 5. Real Estate Syndications.
I am definitely not advocating anything. The successful real estate investors I know seem to be leveraged, exposed to mostly this one asset class, and work very hard at it as their career. It’s just not for me.
Correction, it’s roofstock.com.
Hello, well written/laid out article. My wife and I own 5 rental properties, 4 condos and 1 townhouse. No single family homes or apartment buildings. All of these are part of HOA’s, deliberately so as to take care of the exterior repairs and maintenance. I have always viewed these properties as a PT job, but very erratic in the number of hours needed from us.
We had talked about rentals, and then when the 2006-08 housing bubble popped I felt that there was an over-correction. But, I did my homework, read many books from the library about landlording and talked to people I knew that had landlording experience. All that was worthwhile. I then pitched my wife after 6 months of research and she agreed with some invaluable insights. First, we decided that our model would be condos/townhouses only, as we both worked and didn’t have the time available to maintain a single family residence or apartment buildings. Second, it had to be within 10 miles of our residence (not a problem in the western suburbs of Chicago) and had to be within walking distance of the commuter train line in these communities. That was our model and we learned that not all HOA’s welcome investors, sometimes specifically prohibiting investors owning/renting out units.
Next, you should pull together a team to help you. That should include a good local lawyer, familiar with landlord/tenant law and is willing to help with any issues and a good CPA/Tax person. Tradespeople…Handyperson/plumber/electrician and lastly a contractor or two that can handle major jobs like re-doing kitchens/bathrooms. Make sure you have good/adequate rental insurance, and also consider getting an umbrella coverage for yourself that con protect you if needed. And lastly, your team should include an experienced local real estate agent that can give you good advice and funnel possible properties to you to purchase and rent.
And the best advice besides pulling together a great “Team” is to do a lot of work on the “front-end” of selecting a tenant(s). Have your credit score minimums (ours is 660) and do not deviate from your requirements of tenants. Everyone has a story, sometimes compelling/pitiable, but this is a business…you are not running a social services organization. Doing your best on the front end of looking for tenants will pay off in the avoidance of issues in the future!!
Has it been worth it? I would say yes. Our financial returns have been what we expected. We have had minimal issues with tenants. I firmly believe that taking the time to research landlording, talking to experienced investors, getting a great team to assist, and doing that front end work when screening potential tenants has made our experience a good one. Now that my wife and I are retired, it is certainly a lot easier. I would estimate over a year’s time I average maybe 5-10 hours a week of work, but again it is very erratic. Oh, and BTW, Murphy’s Law does apply in being a landlord, including having a unit two floors above one of our condos having a pipe burst at midnight and flooding all units below it with water, while we were in Hawaii!! LOL And also be prepared for a lot of stories from your friends/relatives etc about the horror stories of having rental properties and crazy/deadbeat tenants!!
Thanks for sharing your experience and wisdom gained Howard.
Best,
Chris
Great article. The only point with which I disagree is saying that REITS do not add diversification to one’s stock portfolio as you say that they move in tandem with other stock sectors. The whole point of asset allocation and portfolio diversification is that the different stock sectors do not move in tandem. Otherwise, I loved your presentation.
Edward,
I agree that REITs provide some diversification and do not move in lock step with stocks. I personally allocate a portion of my portfolio to REITs for that reason.
That said, when you would most want that diversification in the last 2 big crashes (’09 and ’20) the diversification of REITs was more like di-“worsification.” REITs not only dropped in value along with stocks, they tended to fall even further than stocks. That’s not to say that many who held real properties through those times weren’t also hurt, particularly if they needed to sell. But rents tend to be more stable and provide income while riding out the storm.
Best,
Chris
Chris! Great article and summary by Brian. Hope you’re doing well.
As you know, most of my investment focus is centered upon real estate. That said, my wife and do have two 401ks, 403b, and a Roth IRA. Further, we have a 529 plan for the kiddos’ college.
The reason my future focus remains RE is two-fold: degree of control over the asset/investment, as well as ROI. As Brian’s summary stated, there are many different ways to be involved in RE. Some more passive than others. Personally, I’m ok with the degree of active engagement necessary to maintain my successful RE business.
Most of my current projects, except one, boast an ROI between 18-45%. This is only in regard to cash flow (not property value). When property value is factored in, leverage applies and greater returns are realized. For instance, say you invest 40k in a $200k property. You now control and asset worth $200k. Factor in appreciation (which over the last 18 months, saw YOY increases of 9-35% in top 25 MSAs) and you’ve done quite well.
Lastly, with respect to ROI, I actually have a property where I used $0 of my own capital. ROI there is infinite. Am I actively involved? Sure. But its challenging identifying other investments with these giant returns. Therefore I feel it’s worth my time.
This is a great summary of different options – thank you. I did #6 (owner occupied duplex) for many years. I really enjoyed working on it and managing it. After about 10 years, I bought a single-family home to live in and hired a property manager for the duplex. I have to say, they really did an excellent job, and I really appreciated the value they added. As just one example, if a tenant moved out, they were extremely fast at getting the property ready and rented again. I had a full-time job and so could easily miss a month of rent doing everything myself. I know they are not all the same, but we were lucky to have a good one.
Also, I know it was not the focus of your article but one other thing to be aware of is understanding the taxes involved with selling a rental property. I was in it for the long term but after about 30 years our lives changed, and we decided to sell our beloved duplex. I had not dealt with selling a rental property before and so the tax issues were a bit of an eye opener!
The four taxes on the sale of a rental property include: Federal Capital Gains; State Capital Gains; Depreciation Recapture; and Net Investment Income. We looked at various options to defer the taxes like using a regular 1031 and 1031 DST but in the end, we just decided to sell and pay the taxes. In our case, we wanted to simplify and did not want to continue having too much in an Illiquid asset.
Anyway, I wanted to emphasize the positive impact a good property manager can have as well as reviewing tax implications with selling a rental and having a plan around that.
Great article! Could you elaborate on the tax/IRS implications for the private note? Specifically right now I’m involved in a 15 year private note loan that is finally repaying where there will be a loss (remember how great real estate was just before Great Recession). Is there a form I or the entity I was involved with file to let the IRS know the big deposit into my account is a loss? I’ve searched the IRS provisions and can’t find this info. Anyway, private note investors beware- no matter how much you trust someone, things can go very badly on these kinds of deals. Thanks again for such informative content!
I’m starting down the road into buying shares with a real estate syndication sponsor. With larger sponsors (e.g. $100M+ capital raises per fund) who will purchase multiple properties in multiple states, you get instant diversification. I see it as similar to buying a mutual fund but it’s for a portfolio of private properties, hence not that correlated with the stock market. Your money is typically locked up for 5-7 years but you receive quarterly distributions (possibly larger ones if they sell a property). I read the biggest decision factor here is selecting good sponsors (just like mutual funds) so I’ve spent a lot of time trying to research good sponsors (the good ones requires you be an accredited investor and typically have $50k+ minimums). But from everything I read, once purchased, these investments are very passive, just like mutual funds.
I settled in on #5. I just didn’t want to do the work myself.
The syndication game isn’t easy, once I realized I was investing in an entrepreneur as much as a property, it made more sense.
Hands down, out of all those options house hacking is King. You can do it slow, while you live in the house you can attempt different repairs as you become familiar with the house, learn your market as well at no risk and without rush. When you get your ready then take leap.
RE can be work at times but the rewards are unimaginable. The tax benefits are incredible.
I’m a small landlord. I have two rentals and one airbnb. In 6 years i went from having a negative balance sheet too almost half a million. This was done with one teacher salary, my stats home and we have for kids. I couldn’t ask for more.