Real estate is considered one of the safest modes of investment; people will always need homes, and prices for real estate have historically risen reliably, year after year, for many decades. However, there’s more than one way to invest in real estate, and some ways are more profitable than others.
Unfortunately, there are a handful of investment strategies that sound amazing on paper—they seem like they’ll make you the highest potential profit—but in reality, they aren’t nearly as profitable as they sound. So what are these strategies, and why do they sound so attractive if they don’t offer a reliable return?
Timing the Market
Market timing is a strategy that can be applied to almost any type of investing, including stock market and real estate. The idea is to carefully observe patterns in pricing, and buy up real estate when prices are at their lowest. Then, when prices grow back to their usual highs, you’ll be able to sell those investments for a quick profit.
So why isn’t this method profitable?
- The market fluctuates quickly. First, real estate prices vary based on a number of factors, including cyclical movements, economic “shock” factors (like bursts in population growth), and trends like the average salary for people in the area. Determining when a piece of real estate has hit its “lowest” point is difficult, and when you think the market has bottomed out, it’s possible that prices will sink even lower. These fluctuations make it difficult to time your investment with any degree of reliability.
- Individual returns vary. While there is some benefit in looking at the broader trends of the economy and real estate market, the profitability of your investments is going to depend on your individual investments. So, if you buy a house for what’s considered an “average” price in a low-cost neighborhood, and that house is worth less than what you paid for it, even rising prices in the area may not be enough to make up for your value loss. On the contrary, buying an undervalued house in a high-priced market could be valuable, thus undermining the importance of “market timing.”
- Even experts can’t time it perfectly. Even real estate experts, who have been buying and selling houses for years, find it difficult to time the market exactly. This is because there are too many interdependent factors that determine where home prices are headed. And if the experts can’t agree on what the perfect timing is, chances are, you won’t be able to figure it out either.
- One mistake ties up your money indefinitely. Homes are big investments. Unless you have a massive cache of capital to play with, buying a house ties up your money for a long time. Houses aren’t especially liquid assets, and it may be years before the market recovers from its initial drop. Market timing needs to be quick to be profitable, but it often isn’t.
Instead of relying on market fluctuations, you could earn a profit by flipping houses. The idea here is deceptively simple; you’ll buy a house that has a number of problems, such as faulty wiring or bad plumbing, for a low price. Then, you’ll fix everything that’s wrong with it and sell it for more than you paid. What could go wrong with that strategy?
- Costs are difficult to estimate. The most important part of the house flipping process is accurately estimating the costs of both the house and the work you’ll put into it. Before you make your down payment, you’ll need to know exactly how much you’re paying, exactly how much you’ll pay for new materials and labor, and an approximate value of the house once all the work is complete. Too many first-time house flippers end up grossly underestimating the amount of money they’ll need to put into the property, and they end up losing money in the process.
- Your labor has a cost. Even if you’re doing most of the work yourself (i.e., you’re not paying contractors to do it for you), you need to consider the fact that your labor has a cost. If you put in 300 hours of work, but the value of the home only increases by $3,000 (above and beyond material costs), you’ve essentially only made $10 per hour.
- ROI rarely exceeds costs on home improvement. There are a number of home improvement jobs with decent ROI, including installing replacement windows and remodeling the kitchen, but even the highest-ROI jobs come with ROIs in the 80-90 percent range. That means your renovations likely won’t be profitable on an individual basis unless you can find a way to dramatically cut your costs.
Collecting Passive Rent
Collecting rent as a landlord is a good way to stay cash flow positive while your property steadily gains value, but it’s not the hand-over-fist money-making method that people credit it to be. You can’t rake in thousands of dollars a month in profit for a handful of reasons:
- Vacancies are tough to predict. You never know when one of your tenants will leave. When they do, you’ll need to go through the advertising and tenant screening process all over again. Every month you go without a tenant is a month you’ll be without rent—so even a few months of vacancy can tarnish your profitability.
- Being a landlord takes time. You won’t be collecting rent as passively as you might think. Being a landlord takes a serious amount of time; you’ll be responsible for maintaining the property, interviewing new tenants, addressing tenant concerns, and handling other responsibilities. And remember, your time is valuable.
- Repair costs accumulate quickly. In general, you should budget about one percent of a home’s value for maintenance costs—but repair and maintenance costs can accrue quickly, depending on the nature and condition of your property. These costs can quickly throw a wrench in your otherwise sound profitability model.
If you’re interested in ensuring that your real estate investment turns a profit (without having to put hours of work in yourself), consider investing in property management services. At Green Residential, we take care of things like screening tenants and maintaining the property, so you can truly collect rent passively.