Summary: Is investing in real estate good? Or is it too risky? If you’ve been thinking about investing in cashflowing rental properties but have been held back by concerns about the risk of losing your money, consider the risk of doing nothing. In this article, we go over these risks and show you why the risk of doing nothing far surpasses the risks of investing in real estate!
[Disclaimer: We are not accountants, lawyers, or financial advisors, so please consult your own team of professionals about the topics covered in this article.]
We often get the question, is owning rental properties risky?
Our standard answer to this question is that it can be risky IF you don’t know what you’re doing. You wouldn’t operate on a patient without getting the necessary education and training. So why would you dive into real estate investing without the proper training? Therefore, the key is to really educate yourself. And we’re not talking about reading a couple of real estate books and listening to podcasts. You have to learn by doing, just like a surgeon. And the more you do it, the better you get at it. In turn, practice lowers the risk for your patient and for your medical license.
Instead of focusing on how to mitigate the risk of investing, I want to turn the question around and focus on the risk to you and your family if you do nothing. In our opinion, this risk is far greater than the risk of investing in rental properties.
Let’s cover some of these risks:
Wealth Confiscation Through Inflation
Let’s start out by talking about inflation. We covered this topic in the past, but in brief, most think about inflation as the costs of goods going up. While this is true, this is just a symptom of the problem. The real problem is that the value of the U.S. dollar is going down. In fact, since the 1970s, the value of the dollar has gone down by 98%!
This is one of the biggest costs of inaction. Imagine having a nest egg of $1 million dollars that declines in value by 98%! The only way to preserve your wealth is to invest it. Not only that, your investments have to far surpass the rate of inflation. So if inflation is at 10%, your investments better be producing far more than 10%. Index funds aren’t going to cut it.
Now we’re not always in an inflationary environment. Sometimes inflation is more manageable at 1 to 2%. So assuming we aren’t in an inflationary environment, let’s look at the next big cost of inaction: taxes.
Taxes, Your Single Biggest Expense
As high-income earners, we have very few tax deductions. Most tax deductions are phased out when you make above a certain amount. So, this means that very little of your income is sheltered. Therefore, you’ll likely be sitting in the highest income tax bracket.
An easy way to remind yourself how much you pay in taxes is to think about how many months out of the year you work for the government. If you are in the highest bracket, you are giving away your entire paycheck to the government through April or May.
This is what happens to the typical high-income earner. They do nothing and dutifully pay their taxes. They don’t understand how damaging taxes are to growing their wealth.
The table below shows just how damaging it is. Your wealth after 20 years is a fraction of what it could be if it grew tax-free.
What Happens When $1 Doubles Every Year for 20 years…
Add to this risk, the possibility that taxes go up over time. Given the size of our National debt, how high is this risk? Probably approaching 100%.
So if we know that taxes are going to go up, are you just going to sit on the sidelines and do nothing?
It doesn’t have to be this way. With rental properties, you are able to shelter W2 or 1099 income. You can do this by achieving a status called Real Estate Professional Status or with the Short-Term Rental Tax Loophole. Many in our community use one or both and pay zero in Federal income taxes. This is one of the biggest reasons investing in real estate is good!
Want to reap the benefits of Real Estate Professional Status (REPS)? Check out our form below!
Missing Out on Boom Times
Over the last decade, the market has seen insane levels of appreciation. Property values have more than doubled Nationally and even more in some sub-markets (see chart below).
This means, your property would have more than doubled in value, doing absolutely nothing. The cumulative rate of inflation over the last decade is close to 30% so the good news is that your property value is far outpacing inflation.
While all of the above is great news. Even better is that when we invest in rental properties, we don’t even rely on this type of market appreciation. We force appreciation. Forcing appreciation is when you raise the property value by increasing the income that it generates.
So over the last decade, we have been both forcing appreciation AND enjoying the benefits of market appreciation.
The downside for you by sitting on the sidelines is missing out on these high returns. This is also known as opportunity cost and it’s real.
Some might be thinking, what about during a recession? Isn’t it better to sit on the sidelines when times are bad? It’s actually the opposite. Some say, more millionaires are created during recessions than the good times. The reason for this is, you’re able to buy properties at a discount during a recession than during the boom times.
So no matter the market conditions, you’re taking on a lot of risk by doing nothing.
If you’re interested in investing in real estate and you don’t have a dedicated CPA, you’re going to need one! If you want to work with one of our recommended CPA’s, CLICK HERE for a referral.
The Eighth Wonder of the World
Albert Einstein once called compound interest, “the eighth wonder of the world.”
Every year you sit on the sidelines is a year you could have received compound interest from your investments.
Compound interest is what was illustrated in the table above. It’s when you start out with $1, double it every year for 20 years and end up with over $1 million.
While the effects of compounding might not seem like a lot when you’re talking about a 10% rate of return, we aren’t going for a 10% return on our investments. We’re going for much higher returns when we invest in rental properties. This happens because you’re combining leverage (using the bank’s money to invest in properties), cashflow, appreciation (both market and forced appreciation), tax savings, and debt paydown. With these higher returns, this is when compound interest becomes much more significant.
This is when you don’t want to miss out on the “eight wonder of the world.”
So the next time you find yourself asking if investing in rentals is risky, or if it is a good idea, think about the risks of doing nothing. In our opinion, we think the risk of doing nothing is far greater than the risk of investing in rental properties. And when you lower the risk of investing in rental properties by properly educating yourself, you won’t have a choice but to take action!
Remember, investing in real estate is good if you do it correctly and properly educate yourself! Ready to take action?
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