Should People Invest in Real Estate?

One of the contentious questions David Chilton, The Wealthy Barber, asked me on his podcast is whether people should invest in real estate.  This is an emotional subject for many, and all of us come to the discussion with different experiences and skills.

We are really asking three different questions here:

1. Should you own your home or rent?
2. Should you own rental properties?
3. Should you invest in REITs (real estate investment trusts)?

Should you own your home or rent?

There are many factors to consider.  Let’s focus on money first.  Are you better off from a purely financial point of view to own your home or rent a comparable home?  If you’re an emotionless robot when it comes to investing and saving, and you understand low-cost index investing, then the answer is usually that renting is better financially.  In rare markets, this can flip, but renting wins most of the time.

But people aren’t emotionless robots.  They often invest their savings terribly, and they spend savings when they shouldn't.  They often invest at bank branches or with other investment firms that charge high fees.  All these things can tip the scale towards owning a home rather than renting.  As long as you don’t get in over your head on a mortgage, the forced savings is helpful.

There is more to life than finances.  I have become mostly an emotionless robot when it comes to investing, yet I own my home.  I know I’d be wealthier renting a comparable home, yet I own anyway.  Why?  Why does anyone buy anything?  I’d be richer if I didn’t buy a car or new sports equipment or anything else I want.  I own my home because I like the feeling of permanence, the lack of a landlord, and many other reasons.  I’m happy to forgo additional wealth.  Others prefer to rent because they like the freedom, lack of maintenance, and many other reasons.

Some say that there aren’t many homes available for rent.  How many do they need?  There aren’t many houses for rent in my neighbourhood, but there are some, and that makes renting a viable option for me.

To say “I own my home because I want to own it” should be enough, but many people can’t help themselves.  They continue “and besides, I’ve come out ahead owning a home instead of renting.”  Few people can run the numbers on this correctly.  Rent is one big visible number, but homeownership costs are many numbers that have to be added up.  People leave out or underestimate home maintenance, insurance, property taxes, utilities, and real estate transaction fees.  While house prices were on a tear for many years until recently, the stock market has been on a bigger tear.

Compared to renting and investing the difference with low-cost index investing, few homeowners can truly say their home has been a financial win.  It might be a financial win for those who aren’t good at investing and saving, but you just can’t trust them to do the comparison calculations correctly.

There are some excellent rent vs. buy calculators available for those who are prepared to make their decision based on money.  They can either get a good sense of which choice is better financially, or they can tinker with the inputs until they get the answer they want.  The tinkerers would be better off just admitting they want to own for non-financial reasons.

Should you own rental properties?

Do you want a part-time job?  Are you good at doing your own repairs?  Are you knowledgeable enough about major repairs to get them done at a reasonable cost?  Can you say no to tenant requests, even when they appear to be in need?  Can you handle periods of time with no tenants?  Do the changing laws making it easier for tenants to stay without paying rent scare you?  Do you know enough to tell if a property management company you’ve hired is fleecing you?

If none of these questions scares you, then you may be well-suited to owning rental properties and being a landlord.  They all scare me, so I’m not interested.

Once again, I don’t see many people who can run the numbers correctly to tell how much they are making from their rental property investments.  Fortunately, it’s the ones who invest this way for many years who tend to run the numbers well.  Those who get out of rental real estate will often say “I broke even,” but they never really worked it out.

The type of rental property investor who has been burned badly in recent years is the one who bought saying “I’ll make my money on price increases; rents don’t matter.”  Sensible landlords do a careful analysis of purchase price, expected expenses, and expected rents, among other considerations.  Blindly hoping to get bailed out by property appreciation isn’t a good plan.

Should you invest in REITs?

I don’t feel strongly about this question. Through indexing investing, I own a slice of most publicly-traded companies on the planet.  Collectively, they own a lot of real estate, so I’m indirectly invested in real estate. I don’t own any REITs myself, but I’m not against them.  

A big advantage of just investing in stocks and bonds is simplicity.  With each new asset class you add to your portfolio, complexity grows.  What looks like manageable complexity in theory becomes unmanageable in practice.  For those who thrive on managing endless details, complexity is fine.  For the vast majority, simpler is better.  To each his own.