Investing in Real Estate? Think About These 3 Factors First

It feels like once a week, one of our financial planning clients asks me a version of this question:

"Should we buy an investment property?"

I love that our clients are very motivated to explore opportunities to accelerate their progress toward their financial goals. Getting proactive and seeking out paths to grow wealth is a great thing!

But most people who are curious about investing in real estate have a lot of false assumptions and little knowledge or experience.

After we talk, some clients realize that getting into an investment property would be at total odds with their other goals and priorities, while others realize they actually have a real passion for real estate investing and come away with action items to help them seriously explore the opportunity.

Here's the response I give to my clients when they ask about buying investment property.

1. Make sure the tactic aligns with your strategy

The first point I get clear on is why a client wants to explore this idea. When the answer is "because I want passive income," I know it's time to take a step back.

Investment properties can produce income, and they can provide returns. But virtually no real estate investment is truly passive income.

Real estate typically requires a lot of work and upfront capital. You may or may not have cash available to deploy, especially if you're buying and managing the project as an individual (versus an entity like a developer, whose entire business is real estate).

Even if you have the money available to put into a property, you have to consider the opportunity cost. What else could you have done with that money other than buy a property you hope provides a return?

There are other effective tactics — namely, investing in a diversified portfolio in the financial markets — that are likely to produce better results with less risk (and work!) than investment properties.

2. Consider the tradeoffs and accept them (or not) with intentionality

Perhaps your interest in investment properties comes from a desire to start a real estate business.

Or maybe you like the idea of buying a multifamily to live in one unit while renting the others to help subsidize a mortgage cost.

As long as you aren't motivated by the illusion of quick, easy money, we can dig further into planning considerations.

That means looking at the upsides as well as the tradeoffs to ensure pursuing this goal does not interfere with any other stated priorities.

Because you need a large cash outlay to purchase a property, trying to buy real estate might mean delaying or even abandoning other financial goals and options.

Are you willing to incur that opportunity cost? And can you afford to do so?

You might need to cut back on spending so you have available cash flow to direct toward management and repairs on your property, for example. Or you might have to adjust your target retirement date if you redirect some of your assets to this project (thereby taking them away from the pool that's supposed to fund your lifestyle after you stop working).

Because of this, it's a good idea to ask questions like:

• How does this impact your other stated goals and priorities?
• Will it take away from something that is more important for you to accomplish, or does it align with your values and what you want to do with your resources of time, money, and energy?
• Do you want to bear the responsibility of owning and maintaining an investment property? Even if you use a property management company, this is not a set-it-and-forget-it undertaking.
• How much do you know about owning real estate of any kind? Are you willing to spend considerable time and money to learn and gain experience in this area?
• Are you familiar with the logistics, maintenance, upkeep, and management required on the type of property you want to buy?

There's no objective right or wrong answer when it comes to making tradeoffs. What's important is in acknowledging the future impact and potential consequences of your decisions today, whatever they may be.

3. Avoid unforced errors

When it comes to financial decisions, most clients want to know what the "right" choice is.

It's reasonable to focus on that, but what might be even more important is to know the wrong decisions to easily avoid.

The worst mistakes to make are those that come from unforced errors: decisions you didn't have to make, or situations you didn't have to get yourself into.

Part of my job as a financial advisor is to remove the rose-colored glasses and point out the potential pitfalls that are easy to gloss over when you're only focused on the upside.

It's not to say the opportunity isn't real — but that any opportunity comes with downside risk, and you have to consider the impact of realizing those risks as part of the broader decision.

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