Steel industry pioneer Andrew Carnegie said, “Ninety percent of all millionaires became so through owning real estate. More money has been made in real estate than in all industrial investments combined.” Carnegie amassed a fortune of $350 million by 1890, equivalent to about $5 billion today. So, what are some lessons we can glean from his success?
First is generosity – he gave away most of his wealth. Second is change – his wealth today would rank about #400 on Forbes list of billionaires illustrating the shift from the Industrial to the Information Age. Nevertheless, real estate plays an important role in your financial planning puzzle.
I recall a story about a successful real estate investor, Coni. Coni went to her credit union 20 years ago for a line of credit and was told to come back in six months with what she had saved. She ate tuna fish, saved $500 a month, qualified for a $9,500 loan, and used that money to purchase a piece of property adjacent to an airport. She kept eating tuna, paid off the loan and she sold the property to the airport for double what she had paid for it.
She then bought a duplex that generated monthly income. Her goal was to buy more properties capable of making her as much money as her current salary. She accomplished that in five years and learned much about property management.
Coni’s story is like other successful investors – have a plan, take action and work the plan. The difference is she chose real estate as her primary investment.
Real estate’s role in your wealth
Real estate represents a significant component of household wealth. Different types of property include residential, commercial, industrial and land. According to a recent report from the Federal Reserve, real estate comprises about 25 percent of overall U.S. household wealth. Real estate is important because it’s one of the essential human needs (food, shelter and clothing) and tangible (you can “see” it). Investment-wise it plays two key roles. (Note: Home doesn’t normally count as an investment – it’s a “use” asset). First, it’s a major asset class in portfolios (stocks, bonds, cash, commodities and real estate) – they complement one another. Secondly, investments generally pay one of two types of returns – income and capital appreciation – real estate can provide both.
Active owner or investor?
There are two ways to own real estate – direct or indirect. The main difference is about control. Direct investment means outright ownership or partnership, and you’re responsible financially and to manage. Indirect investment is through a limited partnership, a corporation or real estate investment trust – you do not have control, others manage the property. Each form of ownership has unique advantages. For example, Coni wanted to be hands on; however, down the road, she may gladly pass on the management blisters and headaches to someone else.
Is now the time to invest in real estate?
It depends. What are you trying to accomplish? How large is the investment?
Huddle with your trusted advisors – Is it purely for investment or part of a strategic business expansion or relocation? One involves your personal wealth and life plan, and the other may be more urgent and complex with banking, tax, regulatory and other issues. Also, “real estate” is not homogeneous – every property, type and region are unique.
Real estate can be capital intensive. Also, prudent investors diversify and use leverage sparingly. Consider the example of buying a long-term rental. A median priced home in Reno is $360,000. Renting for $1,900 a month will yield about 5.4 percent in cash flow (before income taxes). That assumes a 15 percent expense factor (property taxes and insurance; no expenses for utilities, repairs or turnover). The total return (income plus appreciation) averaged about 8.1 percent for the past 15 years. Not bad! However, what if you had $60,000 for a down payment and borrowed the rest? Mortgage payments would leave only $95 in monthly net cash (for repairs, etc.). You’re praying for no repairs, no recession or bad tenants, and counting on appreciation. Or you look at alternative ways to invest in real estate such as liquid real estate investment trusts. The FTSE NAREIT All REITs Index returned 8.4 percent for the past 15 years. This is just an example to consider for diversification, liquidity and convenience.
Real estate is an important part of a three-legged stool investment approach. And hopefully, when you hear Mark Twain’s quote, “Buy land, they’re not making it anymore,” you have additional insights on how you can diversify your portfolio.
Secure your future wisely.
Brian Loy, CFA, CFP, is president of Reno-based Sage Financial Advisors Inc.