A co-worker told me she bought a house as a rental property in Las Vegas (we are nowhere near Las Vegas). She said a few other co-workers thought it was a great idea and bought there too.
Clark Howard, a consumer advocate and personal finance guru on radio, also says now it’s a great time to buy a home, either to live in or as a rental property.
So far all my investments are in stocks and bonds. I’m not sure if the home I live in counts as an investment in real estate. Suppose it doesn’t, should I diversify my investments with a rental property?
On one hand, more diversification is good. A rental property receives a stream of rent payments. Allowed depreciation makes the rent income more tax efficient. If the value of the property appreciates when I sell, that’s another source of income. All these probably have low correlation with stocks and bonds. It seems my investments would be more diversified if I add rental real estate.
On the other hand, I will have just one property, in one specific neighborhood, in one specific part of the country. It would be very much like buying a single stock — be it Apple, Exxon Mobil, or Wal-Mart. It smacks of speculation to me. After being bitten by speculation some years ago, I swore I would never do that again. It seems adding a rental property would actually make my investments less diversified.
I’m not sure if it’s actually more diversification or less diversification if I add a rental property to the mix.
A rental property is clearly not as liquid as stocks and bonds. If I want to be out of some mutual funds or ETFs, all it takes is a few mouse clicks. I would get the true value less a negligible amount. If I ever want to be out of a rental property, it would take so much longer and cost so much more.
That’s also a reason an illiquid investment such as a rental property can give a good return because it has to sell at a lower price multiple in order to attract buyers.
I’m tolerant of illiquidity to a certain extent. I invest in I Bonds, muni bonds and CDs instead of Treasuries when I trade illiquidity for a higher return. But we are talking about a magnitude of difference here. Compared to a rental property, I Bonds, muni bonds and CDs are super liquid.
Besides the initial investment, say I buy a rental property outright, I will still have carrying costs such as property tax, insurance, and maintenance, whether the rent is able to cover them or not. With stocks and bonds, the worst case would be that they don’t pay me anything; I will never be cash flow negative. Not so with rental real estate.
How do I find tenants, collect rent and manage the property when I’m far away from Las Vegas? My co-worker said don’t worry, a property manager will take care of all those for you. I just sit back, relax, and collect rents (after paying a cut to the property manager).
I somehow doubt it would be that easy. I imagine many decisions will still have to come to me. Investments in stocks and bonds don’t require much involvement at all. Dividends and interest come automatically without me lifting a finger. If I’m away for a month, nothing would happen. I like that.
I think adding a rental property would add stress to my life. With a busy work schedule, I don’t need any more stress. It could be very profitable though. I know people who retired in their early 40s because they made a lot of money from rental properties. From listening to Clark Howard, I got the impression that investing in rental property is quite widespread. I tried to look for census data for what percent of the population owns a rental property. I haven’t found any. Does anyone know?
Maybe it’s a great opportunity. I will leave it to others.
See All Your Accounts In One Place
Track your net worth, asset allocation, and portfolio performance with free financial tools from Personal Capital.