Conservative investors or people who believe that stocks are too risky often prefer to put their hard earned money in real estate. The usual arguments are always the same and go something along those lines:
- It’s a “real” asset, meaning that you can touch it, you can see it, you can visit it or live in it
- It’s a safe investment because real estate rarely loses value
- It’s generating regular and re-occurring income on a predictable basis
I will get on all three points but the focus will be on the last one: Generating regular and re-occurring income on a predictable basis. This is what we call cash-flow, and I will tell you why it’s such a powerful tool.
A “real” asset
This is a very true point and among the main reasons why people like real estate. Probably most of us have this little dream, of having our own place that we call home. Where we don’t need to pay rent, where we can do what we want and how we want it. Where the only limitation to our creativity and our wish on how to shape it is only our own imagination and the available budget to follow through on it.
So let me tell you first that this is, and probably will remain a dream. The sheer amount of regulations imposed on house construction, building permits, safety requirements, and local rules & regulations will restrict how your house has to be shaped, what building material you are allowed to use, where the doors and windows need to be placed and much more. So, there will be many things to restrict you, and you won’t be able to decide on your own every single part of your dream. You still got to follow some rules.
Second, while it is a so-called “hard” or “physical” asset, it comes with a few flaws that are worth mentioning and required to think about. While you might save money on rent, there are tons of other considerable costs that will strongly diminish your return on investment and may even put you in financial trouble if you are not well prepared for them.
Broken toilets, pipes, roofs, and floors are just one part of it. But new legislation or state laws might come in at very unfortunate moments and force you to spend much more than you bargained for. For example, imagine that the government decided that all houses require to become more energy efficient and thus you will have to upgrade the entire house insulation. A toilet or a pipe might set you back only a few hundred Euros, but a broken roof or house insulation will quickly go to the thousands.
This one doesn’t require too much explanation, I mean the last housing crisis is not that far back. So yes, there is a real risk that real estate also may lose value. But while this point might still be debatable, the more interesting challenge for real estate is about the trading of the asset itself.
Buying and selling real estate is just hard work. It’s not easy at all. It’s not easy to initiate the sales, not easy to find buyers, not easy to negotiate the price and certainly not easy to process the whole thing with banks and all involved parties. Because while for some areas it might be easy to find a place to buy, when it comes to selling the property things can turn really challenging. Finding a buyer takes time, negotiating the price takes time. And the result is everything but certain.
Therefore, and to sum it up, the promised or expected value increase might turn out very different once you deduct all the cost you had to cover over the years holding it, and on top of that, if your few potential buyers won’t be willing to pay your expected price.
It’s generating a steady cash-flow
Whether you save money on rent or cash in rent from your tenants, real estate generates solid and predictable cash-flows every single month. And depending on the size, location and attractiveness of the property, it may be some quite serious money.
Cash-flow is great for a few reasons. For one, it makes you feel to be in control over your asset, it feels safe and very predictable, and you see the result of your investment immediately on your bank account.
Furthermore, due to those regular payments, you are able to manage your cash more actively and spent or re-invest on a frequent and dependable basis. The greatest advantage of solid cash-flows is your control over the money and many real estate investors consider it therefore superior to owning stocks.
There is another way
I got to admit that cash-flow is probably one of THE arguments to bring to the table on any investment discussion. It simply represents everything we expect from an investment: Receiving cash back straight to your account.
However, I argue that you can reach this with stocks in a much better, smarter, faster and easier way, and you are still able to choose whether you invest in companies or real estate.
Dividends also generate cash-flow
To start off, most company stocks that I invest in pay dividends. That’s my cash-flow and it’s also very important to me. Not only does it feel good to receive cash regularly, but even more it allows me to re-invest my earnings. This means that I can take advantage of upcoming opportunities to either reduce my investment costs (cost-average-effect) or furthermore increase my earnings by adding more shares of the same or another company. No matter which of these 2 options I choose, the result will be the same: The number of my shares will increase and so will the amount of my next dividend payment(s). Albert Einstein called it the 8th world-wonder and we all know it from our school-days as the 2 magic words: Compound interest.
Dividend-paying companies have all different policies and they tend to be also very diverse, depending on the country and company profile. But even the very average investor can manage to buy stocks to receive dividends every single month. Hell, just take a look at one of my previous articles where I show you how to get paid dividends every 2nd week!
Mix the best of both worlds – with REITs
If you think that real estates are still the more secure option then you can do even a much smarter thing that will combine the benefits of regular shares with the advantage of the benefits of real-estate by investing in so-called REITs (Real Estate Investment Trusts). Not only do they distribute a large chunk of their profits in the form of dividends, but also you won’t need to bother with all the physical and hard work that always comes with any physical property that you own. Broken roofs or new regulations won’t be your headache and on top of that, your risk will be spread across a significant amount of properties, as most REITs tend to manage not just one or two, but hundreds of different objects.
Investing in REITs won’t give you the feeling of owning a “real” asset, but it will take away all the hard work, balance your risk, and finally also remove all the trading obstacles. Because REITs can be traded on the stock exchange, finding a buyer or seller is as easy as it possibly can be. Just place the order and watch it being processed in a blink of your eye. It’s so easy.
Last but not least and a very, very, VERY important point to me: You can invest with as little as your wallet lets you. There is no need to talk to banks, take on hefty loans and keep paying back for the next 20-30 years. Borrowing money is called leverage, and it’s a serious thing. As our mastermind Warren Buffett famously said, leverage is the single thing that can crush any investor and you got to be really smart how to use it.
I don’t consider myself smart enough for that, so I prefer to stay away from leverage and instead invest only the money that I have available at the time of my choice.
It’s all about passive income
My personal aim is FIRE – and it means to generate sufficient passive income at some point so I really don’t need to do ANYTHING – unless I want to. That’s what the word “passive” stands for.
Buying and managing hard assets is not matching my definition of passive income. Buying a house or condo requires a lot of work, dedication, and responsibility. All the things that I want to get rid off. Therefore, stocks and REITs are for me a much more desirable solution.
This is, by the way, the reason why financial advisors need to evaluate your character, risk factor and expectations before helping you on making an investing decision. So you might want to ask yourself now: What kind of investor are you?