Investment is all about risk but where does Real Estate investment stand amongst other types of investments?
Regardless of whether you are intent upon creating a lifestyle or securing your retirement, investing is an essential part of the process. The ability to create passive income streams and to increase your net worth is almost non-existent without doing so. All investments carry some form of risk along with the promise of a return. Both factors are critical to understand, but risk is the one that causes the most confusion.
Risk is a simply a measure of the likelihood the actual performance of an investment is different from the expected performance. In other words, it is a measure of how likely you are to fall short of your goal. Thus, understanding the goal or expected return is critical before making any investment.
As an example, if your goal is grow your portfolio an average of 6% per year for the next 5 years, investing in a 60-month, fixed rate CD that is paying 0.6% is extremely risky. In fact, that strategy is 100% guaranteed to fail. It’s not that the CD won’t return the expected rate, but rather that the investment was never able to achieve the goal.
Once you determine that you want $10,000 per month in passive income or whatever the goal may be, then you can find investments that give you the best opportunity. Calculating the needed Return on Investment (ROI) or number of years to achieve the goal is a fairly straight-forward. Figuring out the amount of risk requires more thought.
The most important thing to understand is that risk is a function of control. The more control you have the lower the risk and vice-versa. If you drive your own car to the store, wear a seatbelt and obey the traffic laws; there is a high probability you will return home safely. You have lots of control. If you are sitting in the back seat and your Uber driver decides he wants to try the next few blocks blind-folded, the chances diminish considerably. You can’t reach the steering wheel, press the pedals or do much of anything other than scream and pray.
When it comes to investments, you need to look at the things you can control. Paper assets like mutual funds offer very little. You can control the purchase price and the amount of the total investment. You can sometimes set a sell-price to minimize your losses when things go poorly. You cannot control the portfolio mix, the decisions of the fund manager, the actions of the CEOs or Board Members, when disruptive technologies are introduced by competitors or much of anything else. It’s much like sitting at a blackjack table. You determine the amount of your bet, whether you stay in the hand and when you walk away. Other than that, it’s mostly screaming and praying.
Real estate investments offer much greater levels of control than paper assets and gambling. You can choose the where you buy your turn key rentals, the type of property, the the level of finish, the target rents, the types of tenants, the lease terms and a multitude of other factors. While 2008 was a stark reminder that property values do not always increase, that period also reinforced the fact that cash-flowing properties perform very well in an economic downturn. Regardless of the value of the house, those that had income-producing properties prospered. Thanks to the market resurgence, these investors have gained net worth as well.
To reiterate, there is some measure of risk in any investment. Once you understand your goals, you can then determine your required ROI and focus on ways to reduce risk so that you can have the lifestyle, the retirement, the legacy or whatever else you want. The most important aspect of limiting that risk is making investments where you have control.