Real Estate Investing
Rental property is a leveraged, concentrated, part-time job. The real returns after costs and vacancies, compared with simply buying an index fund.
Real Estate Investing
A $300,000 house bought with $60,000 down turns a 10% rise in the price into a 50% gain on your money. The same house falling 10% takes half your equity with it. Both halves of that sentence are true, and only one of them is repeated at the viewing.
Property is a good asset class with an unusually large catch. Where it belongs in your portfolio depends on whether you want to own it through a fund or through a mortgage, and those are two different investments wearing the same name.
What property does that a fund does not
| Advantage | The catch |
|---|---|
| Borrowed money multiplies the result | It multiplies it in both directions |
| Rents tend to follow inflation | Tenants, vacancies and repairs follow too |
| Depreciation can offset rental income | You need rental income for it to offset |
| You control the asset | You cannot sell 3% of it in a bad month |
| Tangible, understandable | Your home is already a large bet on one city |
The fourth row is the one people underestimate. A listed fund can be sold in seconds at the market price. A building takes months to sell, costs a percentage of its value to transact, and cannot be split. If your emergency fund is thin, an investment property makes the problem worse, not better.
For most people building wealth on a normal income, the honest answer is a small allocation to listed property funds inside an index portfolio, plus a home if they want one. A second property is a business, and it should be judged like one.
The borrowed-money effect
The house did the same thing in every case. Only the direction changed.
Illustrative. $300,000 property, $60,000 down, before transaction costs and mortgage payments.
The mortgage balance does not move when the price does. That is the whole mechanism. You put in $60,000, you borrowed $240,000, and every dollar of price change lands on your $60,000 rather than on the $300,000.
This is why property builds wealth faster than most people expect during good years, and why it ruins people during bad ones. Borrowed money is not a bonus. It is a decision to make your outcome larger, and the lenders who provide it are protected by the collateral while you carry the risk.
The round trip costs money before it pays anything
- Value at 3% a year
- What a sale must clear
$27,000 of buying and selling costs have to be earned back before the house has made you a cent.
Illustrative. $300,000 purchase, 9% total round-trip costs, prices rising 3% a year.
Closing costs on the way in are typically 3% or so: lender fees, title, appraisal, transfer taxes. Selling costs of roughly 6% come out on the way out. Together that is 9% of the purchase price, or $27,000 of friction on a $300,000 house, and it buys you nothing. Prices rising at 3% a year need three full years to get you back to where you started.
This is the arithmetic behind the rule that you should not buy unless you plan to stay five years or more. Below that, the transaction costs usually beat the appreciation, and renting plus investing the difference wins. Above it, the ownership case gets stronger, especially once the mortgage is paid down.
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