By now, you’ve heard about how real estate is a great way to build wealth. I don’t disagree with that. However, before getting started, you should also consider the downsides of owning real estate and the opportunity costs. For most real estate investors, it’s better to be a limited partner or take on roles that don’t involve much of the day-to-day operations, which I’ll discuss in more detail.
Here are some of the downsides of owning your own real estate.
Downsides of Owning Real Estate
Being a landlord
As you already know, being a landlord and doing your own property management is very tough. For one, you’re responsible for the property and everything that goes on. This includes finding and screening tenants, maintaining the property, and dealing with any issues that may arise.
Additionally, you’re also responsible for collecting rent and ensuring that your tenants are paying on time. If they’re consecutively late, you may have to pursue legal action to get the money you’re owed.
Furthermore, being a landlord also means that you’re responsible for any damages that may occur to the property. This can be a financial burden, as you may have to pay for repairs out of your own pocket.
Being the asset manager
Let’s say you eliminated these responsibilities by hiring a property manager. This seems like a good idea, but it’s tough to find a great property manager (PM), even for a large apartment building (however, you can find one through BiggerPockets here).
Even with a PM, you ultimately still have to be the asset manager, which has multiple functionalities, including managing the PM and making sure that they’re doing their job.
Here are some responsibilities as an asset manager:
Making sure that the property remains in good condition.
Controlling your operating expenses.
Making sure the rooms are rented at market rate. This sounds simple, but it’s much easier for your PM to rent out the units at 5-10% below market rate, so that’s what they’ll usually do.
Making sure your PM is not stealing your money, which can happen through leases or by marking up maintenance requests.
Monitoring the pro forma, including rent growth, vacancy rate, concessions, etc.
Preparing the asset for sale.
Dealing with loans and accounting.
Be prepared to take over PM responsibilities at any moment.
Basically, even if you hire a property manager, your investment is still not considered passive income. There are still many tasks to take care of and plenty of issues to deal with, so don’t assume that your real estate investments will be passive income and you can do it on the side. Some can actually become huge headaches.
Starting small
Another common misconception that beginning real estate investors have is that “it’s better to start small.” The risks are actually higher when owning smaller properties because having a few bad tenants can really hurt your business. Whereas in a 100-unit apartment complex, two or three bad tenants are only a small portion of the overall building.
Additionally, bigger projects can afford you to hire full-time staff, which will make your job much easier.
House hacking
House hacking is a popular strategy nowadays. Buying a duplex or triplex and renting out the other units to get a healthy cash flow, refinance this property, then repeat, is a great way to build financial wealth step by step, but there are some major downfalls.
The first downfall is that this will only work in a secondary or tertiary market. It’s almost impossible to cash flow well in a gateway market like New York, Los Angeles, or Seattle. If your rental revenue can cover the debt service, you’re doing well already.
The second downfall is your living quality is limited. Depending on the circumstances, you might be living with strangers inside your own unit, which can be bad if they turn out to be terrible roommates. Obviously, if your screening methods aren’t sound, you could be stuck in a bad situation for a long time.
Smarter Ways To Build Wealth
Although what I’ve been saying seems discouraging, I’m not proclaiming that owning your own property is entirely a terrible idea.
What I want to emphasize is the opportunity cost of your money and time. We all have limited time on this Earth, so let’s think about how we can utilize it to our advantage. Here are some tips on how you can invest smarter.
Investing in a syndication
A good operator can make great profits consistently. I’ve seen portfolios with over 30% historical IRR on average. With this type of return, you can basically double your equity every three years.
It’s very important that you do enough upfront work to understand the operator’s strategy. There are many things to consider when choosing an operator, so here’s an article on this topic.
As a limited partner, there isn’t really anything that you need to do besides waiting for payday. Some operators focus on cash flow, while others focus on doubling your money as quickly as possible. The latter is generally riskier. There aren’t many investments that can beat the returns of a good real estate syndication. Why bother spending hours every week on your own deal when you could achieve better results by spending a few hours a year?
Being a general partner
If you want to be part of a syndication as a general partner but don’t want to deal with the day-to-day operations, such as asset management, construction management, sourcing deals, etc., then here are a few responsibilities that you can take on.
Loan Guarantor – If the syndication requires a recourse loan, then a loan guarantor is needed. The guarantor needs to have enough assets and liquidity.
Capital Raising – This might be the perfect role for you if you have a strong network. It varies from case to case, but usually, you have to raise at least 30% of the required capital.
Diversification
Even among real estate syndications, there are many ways to diversify your portfolio. In terms of property type, you might want to invest in more than one type of property. For example, COVID-19 halted the hospitality industry but boosted the demand for industrial properties, so don’t put all your eggs in the same basket.
You can still diversify even when investing in the same property type. Multifamily, for example, varies significantly from market to market. An important attribute of a market is its location quotient, which is an indicator of the professional specialization in the area. For example, San Francisco has a very high location quotient in technology, so when many people in technology are suddenly allowed to work from anywhere, the multifamily industry in San Francisco collapsed. Even today, the market is still recovering from the pandemic. On the other hand, the multifamily markets in Austin, Phoenix, and New York have been doing extremely well.
What’s Your Passion?
The majority of real estate investors are here to gain financial freedom. Most people aren’t waking up every day excited about going to The Home Depot and doing another house flip. This is why we should think about what exactly we’re giving up by getting into real estate. Would you rather spend all your hours doing real estate? Or would you rather find a profession that you’re truly passionate about? Excel in your passion, make enough money to invest in real estate passively and build wealth.
I’m personally very passionate about real estate and obsessed with how co-living can bring people together and revolutionize the multifamily industry. I believe in building communities where everyone can feel like they belong, which is why I’m an active developer and don’t want to be on the sidelines.
I hope you’re also passionate about real estate in your own way, so I want to hear about what brought you to real estate. Please comment below.