If you’re considering investing in real estate, you’re likely aware of the potential rewards and risks involved. Real estate has long been a popular investment option for those looking to build wealth or earn passive income, but it’s important to consider the pros and cons carefully before jumping in. Here are some key points to keep in mind:
Potential for appreciation
One of the biggest advantages of real estate investing is the potential for appreciation — the increase in value of a property over time. Real estate generally appreciates in value, and some properties can appreciate significantly, resulting in substantial profits. Appreciation can be driven by factors such as inflation, supply and demand, and local market conditions. In some cases, you can even force appreciation by making improvements to a property.
However, appreciation is typically a long-term strategy. It’s never guaranteed, and you may need to hold onto a property for several years to realize significant gains. “While property prices tend to rise over time, there’s always a risk of selling a property at a loss — the 2008 financial crisis is a reminder of that,” says NerdWallet investment expert Kevin Voigt. Additionally, the rate of appreciation varies greatly depending on location.
Potential for cash flow
Another advantage of real estate investing is the ability to generate cash flow. “Some real estate is cash-generating, such as an apartment building, rental houses, storage sheds, or a strip mall where you pay expenses, tenants pay rent, and you keep the difference as profit,” explains Joshua Kennon, co-founder of Kennon-Green & Co., and writer for The Balance. In some cases, you can also use strategies such as flipping or wholesaling to generate cash flow. Cash flow can provide a steady stream of income, which can be especially beneficial if you are looking to generate passive income or supplement your existing income.
But just as with appreciation, cash flow is never guaranteed and can fluctuate based on various factors like vacancy rates, rental rates, and maintenance costs. “If you find yourself with a higher-than-usual vacancy rate due to factors beyond your control, you could actually end up losing money every month,” Kennon says.
Real estate investing can provide diversification benefits. By investing in real estate, you can diversify your portfolio beyond traditional investments such as stocks and bonds. “Real estate ownership is generally considered a hedge against inflation, as home values and rents typically increase with inflation,” Voigt says. However, real estate investments have downsides compared to traditional stocks and bonds, such as low liquidity and high transaction costs.
High barriers to entry
One of the biggest cons of real estate investing is the high barriers to entry. Real estate investments typically require a significant amount of capital, which can make it difficult for investors to get started. Additionally, investing in real estate requires a certain level of knowledge and expertise, which presents yet another barrier to entry. Furthermore, real estate itself may require much more hands-on labor. The work of maintaining properties, especially rental properties, cannot be understated. As Kennon points out, “Even if you hire a property manager to take care of your real estate investments, managing your investment will still require occasional meetings and oversight.”
Real estate investing can be a great way to diversify your portfolio and potentially earn passive income. However, make sure to weigh the pros and cons before making any investment decisions. While the potential for appreciation and passive income may be appealing, the initial costs and time commitment can be significant hurdles to overcome.