The Common Sense Investor

Most people think that the way to make money in real estate is through appreciation, but in most cases, you can’t rely on appreciation alone.

When someone asks you whether you invest in real estate, the best question to ask back is “what do you mean?” There are several methods to real estate investing, and they are vastly different approaches.

I’m going to suggest that in today’s market, there really are only two consistent ways to make money off real estate, and sad to say, you won’t be making any real money from the home you live in. In fact, real estate appreciation is likely to track or be under the rate of inflation in most locations over the next decade. That means that you won’t become wealthy simply by waiting for time to go by (unless of course you get lucky…but at The Common Sense Investor, we want more than luck).

Before I get into the two ways to make money in real estate, let me suggest that the most popular method isn’t very likely to give you consistent and predicatable results in today’s market. What I’m referring to is the attempt to make money off real estate by “flipping.”

With the flipping strategy, a person buys a house, maybe makes some quick cosmetic changes for a few thousand dollars, and then puts it back on the market for a profit. The problem is that today’s market is so saturated that you’re probably not going to be able to price the house much higher than you bought it for. Flipping really only works easily when real estate is booming, and right now it’s stalling. So flipper beware!

The Two Methods

So how do you make money in real estate? Well, as I said, you can’t count on appreciation doing the job for you, because appreciation is barely keeping up with inflation. In fact, over the long term, housing costs generally track the inflation rate, so this is to be expected. The key is to build profit on top of appreciation. Since appreciation buffers against inflation and taxes, everything else that you can squeeze out of your property will be profit.

Investment Property

In terms of your own home, there really isn’t much capacity for squeezing any more profit out of your home. However, if you purchase an investment property, you can have someone else pay all your expenses plus some of the principal on your mortgage.

One strategy for building a portfolio of investment properties is to rent out your old homes. Whenever you move, don’t sell your home, but rent it out to (make sure to find good renters though!). Make sure that you set your rent price at a market competitive rate where you can at least break even after mortgage and taxes. If you can’t break even, then it is best to simply sell the house.

After a while, when you’ve moved three or four times, you may have three or four investment properties that are all being paid for by the current renters. You are effectively having someone else buy your home for you.

If you’re a little more agressive and want to buy investment properties rather than just keeping your old homes, try to identify those properties for which the rental rate would cover or exceed the mortgage and taxes. If you can do this, then you’re golden.

Real Estate Investment Trusts

The other viable real estate investing option in today’s market is the REIT. With a REIT, you are effectively buying stock in a company that manages income generating commercial real estate. Good REITS are run by professionals who are keen at putting their money into properties with the highest potential return.

One nice thing about REITs is that they focus on commercial properties and are therefore not as susceptible to residential bubbles and crashes. They are somewhat susceptible to a general economic slowdown, but a well run REIT should be able to finesse its way through such conditions, identifying good opportunities to captalize on.

Conclusion

Whether you buy investment properties or REITS, there are still options for the real estate investor. Not all real estate investment depends completely on appreciation, so when appreciation slows down, investors are wrong to think that one must get out of all real estate investing. Rather, the key is to look for good opportunities to hold onto an investment properties or entrust your money with a company that specializes in generating income from commercial properties. In either case, you can continue to build wealth from real estate above and beyond the basic appreciation of residential properties.