Investing in real estate can be a huge step towards securing an asset that will be yours and hopefully worth lots of money someday.
As a millennial, you may want to jump on the investing in property bandwagon as soon as you can.
However, you should take the time to learn what you are doing before you put up any of your hard-earned cash.
As great as a successful real estate investment can be for your financial future, it’s critical to understand both the benefits and the risks.
Here are some things to consider before you step up to the plate and buy your first property.
What Does It Mean To Invest In Real Estate?
Okay, so you’ve decided that it’s a good idea to invest in real estate.
But, what exactly qualifies are real estate anyway?
Technically, real estate comprises land and any man-made developments on it.
Common examples of real estate include houses, apartment buildings, condos, and undeveloped land.
To invest in real estate, you can take many different courses of action.
Some investors pay cash outright and buy the entire parcel in one fell swoop.
However, most real estate investments are a major investment. This requires many investors to take out a loan.
For example, the median home price across the U.S. in mid-2018 is about $216,000. In high-value states like California, the median is more like $600,000.
For most investors, that’s a big chunk of change.
Thus, if you’re trying to buy a home, you might look at taking out a traditional 30-year mortgage.
In that case, you’ll likely have to pay some money upfront, in the form of a down payment. The rest you’ll pay off over the duration of the mortgage.
However, that doesn’t mean you have to keep the home for the full 30 years.
Once you own property, you can sell it whenever you’d like. If prices suddenly spike, you can sell in five years, one year, or even less and take your profit.
One of the drawbacks of investing in real estate, however, is that real estate is not as liquid as some other types of investments.
For example, if you invest in the stock market, you can sell your shares any time the market is open at the then-current price.
With a real estate investment, you have to find a buyer, negotiate a price, and complete extensive paperwork. The whole process can take weeks, months, or even longer.
This adds a layer of complexity to real estate that is different from other investments.
In most cases, you’ll need to work with a real estate professional to guide you along the path.
However, that doesn’t mean that you shouldn’t do your own homework first. As with any investment, you should always know what you’re investing in before you spend any money.
Understanding the Real Estate Market
The real estate market is dynamic, with prices affected by numerous factors, both national and local.
Here are just a few things that can affect the price of a real estate investment:
You’ve likely heard the expression that “location, location, location” is the most important factor when it comes to home prices.
What that really means is that there’s a greater demand for real estate in places where people like to live. Since greater demand translates to higher prices, properties in popular locations tend to be more expensive.
A prime beachfront property is likely in demand. But when analyzing the value of a property’s location, consider its proximity to services and benefits such as schools, grocery stores, or recreational areas.
“Comps” are comparable prices for homes in the immediate area.
Neighborhoods with rising comps tend to increase the appraised value of other homes in the area, so they’re something you should be aware of.
General economic factors
When people feel good about their financial situations, they tend to spend more money, and this includes buying more expensive homes.
So, when do people feel good about their financial situation? In an economic expansion, when everyone who wants a job has one, wages are rising, and people feel more prosperous.
During a recession, when the economy contracts, home prices generally fall as well, right along with incomes.
For astute real estate investors, the best time to buy is often when the economy has crashed but is on the mend.
Interest rates are a big factor when it comes to valuing real estate.
When interest rates rise, it costs more money for new buyers to take out a mortgage loan, and existing homeowners with variable-rate mortgages also end up paying more.
Since rising interest rates increase costs, they tend to drive down home purchases. Reduced demand for housing often drags down prices, based on simple factors of supply and demand.
Countless other factors can impact the value of real estate.
Construction of new amenities can increase the prices in a local area, even in an otherwise cold market.
The arrival of a new employer can boost the fortunes of an individual town, increasing real estate prices in the region.
Changes in tax laws can spur either additional buying or selling.
The bottom line is that it’s critical to understand the real estate market and the area you are shopping in specifically in order to estimate the true values of real estate in the area before you buy.
Get an Emergency Fund Before Investing in Real Estate
Although real estate may be a great investment, it shouldn’t be your first one.
Before you invest in anything, from real estate to the stock market, you should shore up your personal financial situation first.
The most important step you can take before you invest is to establish an emergency fund.
An emergency fund is a repository for funds that you only touch when absolutely necessary.
Most financial experts advise that you should keep between three and six months of income in an emergency fund.
Ideal Size of an Emergency Fund
|To start...||Ideal goal...||Super safe...|
|$1,000||3-6 months of essential expenses||12 months of expenses|
An emergency fund is something like an insurance policy. It prevents you from having to liquidate your investments in order to satisfy short-term unexpected costs, like car repairs or dental work.
This is critical if you’re a real estate investor because real estate is illiquid and generally high value. If all your money is tied up in a house, you’re not going to try to sell the house to pay $500 for a new radiator.
But, where is the money going to come from?
Going into debt isn’t a good option either, as credit card interest rates can easily top 20 percent.
Having an emergency fund avoids both of these situations.
An emergency fund also buys you time if you have longer-term problems.
For example, if you lose your job, you may still have to sell your real estate investment at some point.
But an emergency fund gives you a cushion of three, six, 12 months or even longer to find a job before you have to resort to liquidating your investments.
An online savings account is a good place to stash money in an emergency fund. Look for an account that charges no fees, is insured, and that pays a high interest rate.
If you never have to tap your emergency fund, great! You’ll be earning interest on your money while having the peace of mind that no short-term calamity will wipe out your investment portfolio.
Why It's Good To Invest In Real Estate At A Young Age
Starting any type of investment at a young age is a good idea.
For starters, you’ve got time on your side.
Here are just a few of the reasons why you might consider real estate at a young age:
Compound interest can rapidly grow the value of an investment, but only if you give it time.
Let’s take a hypothetical example of a $200,000 home that appreciates in value 10 percent every year. That’s $20,000 the first year.
However, after 20 years, that home would be worth $1,345,499. In year 21, it would appreciate by $134,549, or six times the amount it gained in year 1.
The younger you start, the faster you’ll enjoy the power of compound growth.
When you buy real estate, you own a hard asset. No one can take that away from you.
In the stock market, if a company goes bankrupt, its stock goes to zero, and you own nothing.
If you own a home, even if the the economy collapses and your home value craters, you still have a place to live.
This can make owning a home a safer investment than buying stocks or cryptocurrencies, which are intangible assets that only have whatever value the markets assign to them.
Credit score boost
It might seem counterintuitive that borrowing money can increase your credit score, but it just might.
In fact, a full 10 percent of your credit score is dedicated to your credit mix.
If you can take out more than one type of loan and show that you can pay it back successfully, your credit score might jump.
So, diversifying your debt profile to include credit cards, auto loans, and home mortgages may actually help you, as long as you make your payments on time and don’t take on excessive debt.
Investing rather than spending
When you rent a home or apartment, that money is gone the moment you spend it. Rent entitles you to a place to live, but that’s it.
Every mortgage payment you make, however, increases your equity in your home. Although a part of the payment goes towards interest, the principal portion of your payment is a true investment.
If you buy the right type of property, you can rent out some or all of it to generate income.
In some cases, you can essentially get paid to live in your house.
For example, if you live on one floor of your home, you might be able to rent out the rest of the house for the amount of your entire mortgage payment.
In that situation, you own your home, and you get to live in your home, but someone else is paying for it.
If you paid for the property outright, or if you’ve already paid off your mortgage, the rental income you earn goes right into your pocket as pure profit.
Why It May Not Be A Good Thing
All investments carry risk, and real estate is no different.
Although a lot of real estate goes up in value over time, nothing is guaranteed.
In some regions, the selloff was even more dramatic, and median prices still remain far below that peak.
If you invested at the peak of the housing market, you might still be underwater.
Another risk to investing in real estate comes in the form of additional costs.
Some investors target the selling price of a home as the amount of money they should set aside. The truth is, if you plan to buy a home for $216,000, your final bill will be much more than that.
Here are a list of fees that are commonly attached to real estate transactions in California, for example, in addition to the sales price:
- Listing agent’s commission
- Buyer’s agent commission
- Notary fees
- Escrow fees
- Title search fees
- Closing cost concessions
- Home warranty cost
- City or county transfer fees
- Homeowner’s association transfer fee
- Termite inspection fee
- Natural hazard disclosure report
- Lien release document fee
Of course, if you plan on living in the house, you’ll also have to factor in furnishings and improvements.
Once you own your property, you’ll have to factor in costs for annual maintenance and upkeep.
On a non-monetary basis, buying and owning real estate can also be stressful.
This is particularly true if you’re looking for a good contractor to perform work on your investment, or if you’re looking for a quality tenant that you can rely on to make timely rent payments.
The biggest stressor of all can come if you don’t have a steady income, or if you lose your job.
If you can’t keep up with your mortgage payments, you may end up losing your home entirely.
We've looked at both the pros and cons of investing in real estate as a young adult, and hopefully, you've learned something along the way about how the industry operates.
Your final takeaway should be that investing in real estate is not a slam dunk; while there are many potential benefits, there are also numerous risks involved.
Ultimately, the choice is yours if you want to invest in real estate.
However, we recommend these three courses of action before you do:
- Have an emergency fund set up before you invest in anything.
- Do research on your markets before you invest.
- Prepare yourself for all possible scenarios.
Real estate investing has lots of moving pieces. But, if you do your research and set yourself up financially, taking the plunge while you’re still young might make sense for you.