Many people own some real estate, and for the most part, those who don’t own property still have the desire to own as a part of their financial forecast.
Whether it’s your primary residence, a second home or an investment property, there are several ways to look at real estate from an investment point of view.
For your home, it may be best to exclude this asset from your inventory of investable assets. In the financial planning world, your home is considered a use asset. A use asset is something that theoretically will always remain something that you need to live, not something where you will be pulling equity to support lifestyle or other purchases. An exception to seeing your home as an investment may be if you down size (and down cost) to pocket sales proceeds above and beyond the cost for a new home.
For a second home, have a clear plan about its use. Do you ever rent it out? If no, then call it a use asset. If you will rent, then analyze it as you would any other property investment. Usually, the basic ways that investors invest in real estate are for speculation and for long term holds hoping for a gain and positive cash flow.
Real estate as a speculative investment is very risky. In the past I’ve seen many investors buy something “on spec” and have it turn around in fairly short order with a gain. I’ve also seen those bought “on spec” that sit on the market for months or years where the owners merely hope to get back as much as their original investment and renovation costs. This gets dangerous if that property is leveraged, as it will increase your carrying costs materially.
Buying real estate for a long term hold could be a part of a long term hold investment strategy. It may lower your overall investment risk, especially if there is rental income or some other sort of cash flow generated. Over the long term, it appears that real estate has appreciated slowly but generally upward over the past century. But if you’ve owned property in the past 30 years, you know that the long term outlook for real estate is merely a bunch of cycles that rise and fall. Your timing, on both the buy and sell side can dramatically impact your overall long term rate of appreciation.
Investing in real estate for cash flow is another popular idea. Whether you’re writing a check or using some leverage, the objective here is to earn cash flow similar or better than a typical fixed income investment with a possibility of some appreciation long term. This also has some risk. Tenants don’t last forever, and some are better than others.
Regardless the reason for owning investment property, ensure to own your property in a protected entity such as an LLC. Done right, it may prevent a catastrophe from wiping out your whole net worth.
John P. Napolitano CFP®, CPA, PFS, MST is Founder and Chairman of Napier Financial in Braintree, MA. Visit napierfinancial.com for more information. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investment and financial planning advice offered through US Financial Advisors, a Registered Investment Advisor.