Should You Invest in Real Estate?

By Douglas Goldstein

Owning real estate and renting out property are popular investment strategies due to the leverage and appreciation potential and the income stream.

Real estate is generally purchased for two reasons: to live in (and hopefully enjoy the appreciation in value of one’s home over the years), and to use as a rental property (and receive monthly income from rental tenants).

Real estate does not always make a good cash-flow vehicle, however. This is because, although the property is tangible, the real estate market can often be as unpredictable as the stock market. If you own stocks, you can check prices on a daily basis and know exactly your portfolio’s value. With a house, however, until you have a signed contract to sell, you can never know exactly how much it’s worth. While I don’t recommend that investors should constantly check stock prices. I don’t go along with the other end of the spectrum, either. Total ignorance of your investment’s value does not make for an educated investor.

When you invest in real estate, the value of a property might change dramatically, due to a variety of reasons. These include ups and downs in the economy, changes in interest rates, property tax raises, and shifts in the ambiance of the neighborhood. But you, as an owner or future owner, might have a difficult time identifying the volatility because there is no public market place for residential homes. Even in the best-case scenario where property values appreciate, you can only benefit from such an appreciation if you are prepared to sell your house and if you can find a buyer who will give you your price.

Rental Income from Real Estate

Real estate bought for rental purposes does not guarantee the owner a profit, either in the form of monthly rental payments or future return of the initial investment. Compare this to a U.S. Government Bond or a CD that can guarantee both a return on principal and a return of one’s original investment. Owning real estate property cannot guarantee profits, because there are a number of risks and costs associated with this type of purchase. Insurance costs, arnona (Israeli property tax), legal costs, and mortgage payments all add up. (Remember that, unlike in the U.S., mortgage interest is not tax-deductible in Israel.)

While there are landlords who think that the benefits of a monthly rental check outweigh the above costs, careful calculations might change their minds:

Say you own a debt-free apartment in Jerusalem worth $250,000. You were lucky enough to find a renter who pays $800 per month. After expenses (including periodic repairs, painting, etc.), you net $700 per month, or $8,400 per year. What happens when a tenant leaves and you cannot find a replacement right away? The empty apartment might very well cost you one month’s rent every year, plus another month’s rent to pay the real estate agent for finding you someone new. So now deduct $1,400 from your yearly income, and you’re left with around $7,000 per year. Even though this is a four-digit figure, does it translate to a high annual return?

In this example you received $7,000 per year on equity of $250,000 (the amount you could get if you sold the property). That’s an annual cash flow of 2.8%. You could probably earn that much by putting your money in the bank, without the hassles of fixing the plumbing, chasing late rent checks or finding new tenants after the lease expires!

Make Your Calculations Properly

All too often people prepare the calculation of total return on a rental property incorrectly. This is because they base their math on the original cost of the property. To correctly calculate your return, you must use the current equity value, since this is the amount of money you could invest elsewhere, if the property were sold.

Real estate is not a very liquid investment. It could take years to sell a property, and even then there is no assurance that you will get the price you ask. If you own a house in the wrong part of town, its value may decrease over time, meaning its sale price might be below its purchase price. Also, if most of your money is tied up in one property, this could represent a real problem with diversification. It is usually very difficult to spread the risk by owning many different properties or other sizable investments, unless you have substantial resources.

A Room of Your Own vs. a Wedding Gift

On the other hand, many people appreciate owning a “useful” investment; after all, a home can provide a benefit that no other financial instrument can – a place to rest your head. Since frequently mortgage payments and rental payments can be of equal size, it can often pay to own your own apartment or house, depending on your situation.

How about the common practice of purchasing an apartment for a child? While it is commendable for a parent to want to assist children in starting married life, it’s important to consider whether this is the best use of one’s funds.

All too often I meet with parents who are concerned that if they don’t purchase an apartment for their daughter she will not be able to get a good shidduch. Frequently some of these well-meaning parents will put a good part of their life’s savings into real estate for their children. While this may help their children start marriage off on solid financial footing, one can only hope the purchased dwelling has an extra room for the parents to live in when they can no longer afford to live on their own! If purchasing one, two, or even more apartments for their offspring will put the parents in a precarious financial position; it is a poor move for everyone involved. Shidduchim should be made based on love, common goals, and compatibility. Financial assistance, although useful and welcome, should not be part of that equation.

Investing in real estate should be an important consideration in your financial planning. But remember, the roof over your head must protect your nest egg, as well as you.

Douglas Goldstein is the director of Profile Investment Services, which sponsors this section. He is a licensed financial professional both in the U.S. and Israel, and helps people who invest in the U.S. He is a member of the Financial Planning Association, and offers securities through Portfolio Resources Group, Inc. a registered broker dealer, Member NASD, SIPC, SIA. For more information, go to www-profile-financial.com or call (02) 624-2788 or (03) 524-0942.