Investments can be analyzed based on 3 main criteria: liquidity, safety, and rate of return. Most investments won’t rank high in all three, instead, there’s some give and take. Investments high in rate of return are usually low in safety, highly liquid investments tend to be less safe, and extremely safe investments tend to be relatively illiquid and have lower rates of return.
Real Estate is no different, however, it has a reputation of being the ultimate investment, so let’s break that down.
Is Real Estate a Liquid Investment?
Real Estate is one of the most illiquid investments you can make. This shouldn’t come as a surprise to anyone who’s bought, sold, financed, or refinanced a home. It can take weeks or months to be approved for a mortgage or to close a sale or purchase transaction, and the mountain of paperwork that goes into it is no fun for anyone.
Is Real Estate a Safe Investment?
A safe investment is one in which the likelihood of losing your money is low, the less likely you are to lose your money in an investment, the safer it is. So, is Real Estate safe? That depends on who you ask; I’m sure the millions of homeowners going through foreclosure right now because of the market crunch wouldn’t think so. The fact is, however, that no matter who you are, and contrary to popular opinion (which is changing pretty fast), Real Estate does not always appreciate.
The safety of real estate is very much tied up in its lack of liquidity as so many homeowners are finding out right now. Fortunately, if you take the proper precautions and keep in mind that real estate values do not always go up, you can protect yourself from much of the risk involved.
Does Real Estate Have A Good Rate of Return?
Did you ever play that rumor game in grade school where the class gets in a circle and one kid whispers something to another kid and so on, and by the time the “rumor” gets back to the original kid it’s completely different from when it started? That’s a lot like how real estate has gotten the reputation it has; some people have made quite a bit of easy money in real estate during market booms and so began the “rumor” that real estate is the ultimate investment. Boatloads of people invest in Real Estate because they think it has a high rate of return, but the truth may surprise you. In spite of the fact that Real Estate prices shot through the roof over the past several years, you might be surprised to know that taking a step back in time reveals a very different picture.
(Source: Forbes.com)
According to this chart taken from Forbes.com, the S&P 500 has stomped the performance of US home prices over a 20-year period. Since 1980, home prices have increased 247%, whereas the S&P 500 shot up over 1,000%, a staggering comparison.
So, Real Estate scores low on 2 of our 3 criteria, and the third criterion, Safety, is arguable. Maybe we should be rethinking that common belief that it’s impossible to lose in real estate. Sure, when approached correctly, real estate can be an incredible investment, but it can’t be approached haphazardly. It’s an investment like any other, and it carries risks and rewards, just be careful before jumping into real estate investing without a plan, because it may turn out that it’s not all it’s cracked up to be.
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10 responses so far ↓
1 Wayne Bienek, Real Estate Web Designer // Nov 6, 2007 at 5:37 pm
Its a very good long term investment.. but good mutual funds are also a good investment.
History has proven these facts. With real estate though, you can put your ‘hands’ on your investment..
Wayne Bienek
http://www.webcontentsolutions.com
2 Marty Dobos // Nov 7, 2007 at 9:45 am
Real Estate investing can be risky but in the long run it can be profitable.
3 Skip // Nov 7, 2007 at 2:00 pm
All of that may be true but it’s what is NOT mentioned that is really important…like the fact that you purchase a $200,000 asset for $10,000 to $20,000 and then rent it out and literally have someone else buy the asset for you as you use the rent to make the payments…OPM (Other People’s Money) anyone. I’d like to see their chart with this data included.
4 John // Nov 7, 2007 at 6:27 pm
Skip, you make a very good point. And as long as you use it in that way (net positive cash flow) it’s a fantastic investment. Thanks for stopping by.
5 October Real Estate Blog Carnival | 3 Minutes // Nov 24, 2008 at 2:03 am
[...] Lending asks if Real Estate really is a good investment.. and discusses analyzing investments based on 3 main criteria: liquidity, safety, and rate of [...]
6 Lorina Krisak // Jan 24, 2009 at 7:39 am
Real Estate is a lucrative investment in any market if you know the right strategies to use for the times. Of course you cannot base this soley on the national market. Local is the biggest factor.
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Skip, like you said, buy&hold investments are probably the best strategy at this time (with OPM, of course
This is probably one of the best times in history to make money in Real Estate. I know I am taking advantage of it! Too bad most will read articles like this and figure the best thing to do is stay away.
7 Peter // Apr 5, 2009 at 12:43 pm
Building on what has already been said, the author based this only on the value of the home as the investment. I own 3 condos and while their prices are down to where I bought them, I still make 300-400/month of each one. I also enjoy a favorable tax return/write-off. At the rate I am going I will have no payments on these 3 properties within 15 years and have a nice stream of income (~3-5k/month). In addition, I don’t take care of the properties..I pay someone to do that as well. It is annoying when financial “experts” shoot down true real estate investing, when they are really just mentioning owning a home. I guess when your a hammer (financial advisor), everything looks like a nail (investing through them exclusively is the best way to make money).
8 RJ // Oct 13, 2009 at 3:50 pm
What the author also fail to mention about the difference between the S&P beating real estate in terms of % increase is that in real estate you can use tremendous leverage to increase wealth. i.e.
you invest $10,000 in an S&P index since 1980 and get 1000% or $200,000
vs
investing $10,ooo in real estate to purchase a home worth $100,000 x 247% or $247,000
Leverage works and it is one of the huge keys to building real estate wealth!
9 John // Oct 13, 2009 at 7:02 pm
@RJ: That’s true, leverage is a powerful thing, which incidentally increases risk. That said, you can buy stocks on margin. Now, whether or not the risk is equal in both cases is a different topic altogether.
10 Pat Rex // Nov 14, 2009 at 5:28 am
No one is arguing that real estate can be a good investment. In order to determine if it’s the BEST investment you should be making you have to look at how much money (equity) you have tied up, and how much you COULD be making in an alternative investment. What is your oppurtunity cost? If you have $100K tied up in equity you have to look at your precentage of return on real estate vs. what you could earn in a mutual fund (for example). If your equity goes up on the property, you technically should raise your rent (or somehow lower your expenses) in order to match what would be an increased return in an alternative investment. It’s a hard one concept to wrap your head around but this is the only way to think about it if your goal is to make the maximum amount of money on your available funds. Of course you must consider safety and liquidity as well.
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