5 Myths About Real Estate Investing

October 03, 2013

With interest rates and home prices still low but rising and economic recovery and/or higher inflation possibly on the horizon, the prospects for real estate are looking pretty good. But it’s not an area that I’m as familiar with as other types of investments so I’ve been talking to a lot of people and doing my own research to better understand real estate investing. Here are some common misconceptions I’ve found that could be inhibiting people’s success in this area:

1)      You need to buy your own home before you invest in rental real estate. I used to take this one for granted myself but when you think about it, it makes no sense. In fact, getting a home (and that nice big fat mortgage payment) typically makes it HARDER to buy rental real estate. After all, you have to deplete your savings for the down payment and closing costs on your home and your new mortgage payment means your higher debt/income ratio makes it harder to qualify for a loan on an investment property. On the other hand, the income from a rental property can actually make it easier for you to buy a home down the road.

2)      Investing in real estate is all about appreciation. This is where people can really get into trouble. It’s true that real estate does go up over time, generally in line with inflation. It’s also true that there have been specific times and places where real estate prices have spiked. But  no one knows for sure where and when that will happen. It’s all speculation. A safer way is to invest for cash flow and have any appreciation as a nice bonus. By investing for cash flow, you’re also more likely to avoid overpriced housing bubbles since home prices can’t get too far away from rents.

3)      Investing in real estate is time intensive. This can definitely be true…if you manage the property yourself. By purchasing a property with good cash flow, you can afford to hire a property management company to take those late night emergency calls.

4)      A great home in a great area is a great investment. There is some truth in this. Be careful of older homes that may require more maintenance and repairs or areas where the job market is weak or too dependent on a particular sector of the economy . On the other hand, real estate can be like stocks. An exciting business isn’t always a good investment and some of the best stocks are the most boring companies.  If anything, a beautiful home in an amazing location is more likely to be overpriced and have negative cash flow. Like with all investing, don’t let emotions get in the way of making money.

5)      You should invest where you live. Put the last two points together and you can start to see why this doesn’t make sense. That’s like only buying stocks in the area you work in. Limiting yourself to your geographic area means missing out on better opportunities in other parts of the country or even the world. Your best real estate investment may be a home in the middle of nowhere that generates enough positive cash flow to be managed by a local property management company and still be profitable. Just because you don’t want to live there doesn’t mean there aren’t people who do and they pay rent just like everyone else.

Learning these concepts completely changed my perspective on real estate investing. I was planning to buy a condo where I live in San Diego first as a home and then as a rental property but with the high prices and HOA fees relative to rents here, that doesn’t seem like such a good idea anymore. On the other hand, that home in the middle of nowhere…