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Risk versus Reward in Real Estate Investments

Before I started my first career, as a derivatives bond trader, my trading company had drilled something into my head…every time I made a trade, I was taught to analyze: “What is the risk; what is the reward?” Meaning, what is the maximum amount I could lose, versus the maximum possible upside I could make?

This simple formula, “risk versus reward”, can be applied to almost anything in our lives: for example, the risk of drunk driving is death; the reward is you save an Uber fare, so maybe you should take that Uber. How about the risk and reward of staying in a bad relationship? The risk is that you’ll miss the opportunity to meet your soulmate. The reward is nothing, because after all, it’s already a bad relationship. So maybe you should get out, ASAP!

We can apply this same analyses for investing options; as far as I am aware, there are only a few investments even worth considering. With low interest rates, Bonds just don’t have enough reward, as while their risk is low, they are considered the safest investments, the reward is minimal, barely keeping pace with inflation. Likewise, precious metals are well known inflation hedges, but with little price appreciation in over a decade and no positive cash flow, there is too little reward (upside). Cash gives you flexibility, but its purchasing power is eaten away by inflation every month, so again, just too little reward to be considered here.

It comes down to stocks versus real estate: many people know the myths propagated by the stock market. Before the end of the twenty-year rally, and going into the year 2000 internet crash, the prevailing wisdom was that “nothing beats stocks over the long term”. We then saw a time when we had a “lost decade” where stocks were basically flat between the years of 2000 and 2010.

So, it seems that while stocks can have great upside, good reward, but also with steady and massive corrections: 2000, 2008/2009- and after an uninterrupted decade run it looks today, the next correction is imminent – meaning the risk is also huge. In addition, market timing can make or break you – for example, buying in 2007 or buying in 2009 would give very different results, and play a huge role in whether stocks will make a good investment or not.

But how about real estate? Historically the S&P has had about 4 times the volatility of the U.S. Real Estate Market. Now of course that is a very broad generalization…. what about the different buildings types – single family homes versus multi-units, Commercial property versus Residential, Alaska versus Los Angeles, etc. But I think the general point is on a risk matrix, real estate wins. Real estate just has less highs and lows, and less overall volatility than the broad US stock market.

What about the reward? Well initially the S&P probably has higher historic returns than the cash returns of most real estate investments, although I would argue that the “best in breed” type of multi-units are likely comparable…BUT that’s only half the story.  Traditionally investors buy with 25% down, meaning the bank leverage of the mortgage will immediately quadruple any upside appreciation. Added the cash on cash income, with bank leverage, we are now way ahead of stocks on the reward metric, as well. And this isn’t even considering the monthly debt pay down of your loan (building your equity over time) as well as the tax benefits of real estate (such as the building “depreciation” and rolling real estate profits between buildings in 1031 Tax Exchanges without paying tax of the profits).

In summary, there is just no better, and no safer, long term investment than real estate – providing it’s the right building in the right area. And also that it’s managed properly. This is why it is incredibly important to work with someone who truly understands this investment model to maximize your long term returns!

#workwithaprovenexpert #mainstreetreg #dunningrealestate

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