Why You Shouldn't Have All Your Money In Real Estate

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Is there any problems with having all your money in only real estate?

That was a question I saw.

The answer is YES there are problems!

1) No diversification. The real estate market tanks and you are hosed. The more so because of the leverage attaching to most real estate investments. If you own five properties with a total value of $3.5 Million maximally leveraged, and the market loses 20% of value, you may have lost more than the entirety of your equity. If you need to get out now for some reason, the fact that prices are down hurts you much worse in real estate than any other investment except maybe commodities. If you had other investments, you likely would be able to hold on until market recovery and still make money.

2) Most people who do it get too strongly leveraged. Leverage is great, it makes your money work harder. But you've got to do some heavy thinking about how much leverage you're going to accept. If your cash flow is positive or tolerable, you can last out downturns. If you get into a situation where you can only make the payments for a certain amount of time, that can create desperation, and force you to accept an offer that leaves you owing money to the lender, and money to the IRS.

3) Real Estate is not liquid. This is the real kicker that drives the first two. You can't just call your stockbroker and get cash in seven days or less. You have to find the right buyer to get a decent price. If you need money in a hurry, this can force you to sell property for less than it's worth. If there are no good offers but you need to sell, you can find yourself forced to accept a bad one.

4) Landlord issues. The more properties you have rented out, the more likely that either blind chance or one of your tenants is going to do something to one of your properties which requires a lot of money in a hurry. If you're maximally leveraged and have no money anywhere else, where are you going to get that money? Particularly if the nature of the damage renders the property uninhabitable, in which case you're not likely to get any new loan on the property until it is fixed, and your lender might just decide to keep any insurance money in order to cut its losses.

If they're not rented out, of course, you're flushing cash every month.

Don't get me wrong. Real Estate is a great way to make money. In fact, given the phenomenon of leverage, you can make more in real estate with less risk than in practically any other investment field. But you've got to have some money somewhere else, and the larger your investment in real estate, the more money you need in other investments.

Caveat Emptor

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About this Entry

This page contains a single entry by Dan Melson published on April 20, 2014 10:00 AM.

Buying and Selling Properties with Unpermitted Additions was the previous entry in this blog.

Lenders Adding Conditions After Loan Closing is the next entry in this blog.

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