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by ANDREW J. MCLEAN and GARY W. ELDRED, PhD
Prologue: DOES INVESTING IN REAL ESTATE STILL MAKE SENSE?
Sky-high prices. High rent multiples. Falling cap rates. Negative cash
flows. Government rules piled higher and deeper. Persistent talk of
real estate bubbles. If you’re beginning to question the wisdom of
investing in real estate, you’re not alone. Open any business newspaper
or financial magazine. You’re bound to see dire predictions about the end
of real estate.
But wait. Before you draw a conclusion ask yourself, can you name
a more profitable alternative? A portfolio of S&P 500 stocks that yield dividends
at a rate of less than 2.0 percent a year? U.S. Treasury bonds that pay
interest of 4.0 to 4.5 percent. Corporate bonds that might give you a point or
two more interest than treasuries? Hedge funds? Private equity? Commodities?
Savings accounts? Certificates of Deposits? I challenge anyone to run
the numbers that will show the superiority of any of these choices.
Even the leading advocate for stocks, Jeremy Siegel (Stocks for the
Long Run, Irwin, 1994), has been eating humble pie. Siegel has now tempered
his advice and forecasts total returns from stocks of six to eight percent
a year (before adjusting for inflation and taxes).
Six to eight percent! That’s hardly the kind of return that will build
wealth and help you achieve financial freedom. That’s hardly the size of
return necessary to fund a comfortable retirement (assuming that you
want to retire prior to age 75 to 80). The fact is that in recent years, investors
have pushed up property prices thus lowering relative cash flows
because they are learning this undebatable truth: Historically, real estate
investors have dramatically out-earned their fellow investors who have
tried to accumulate wealth, income, and financial security via stocks. (As to bonds, commodities, and hedge funds, the investment landscape is littered
with the shriveled net worth of those who attempted to navigate
those rocky roads to real wealth.)
I personally know dozens of people from ordinary walks of life whose
rental properties helped them build net worths that exceed $1,000,000.
I have never met anyone similarly placed who has built a comparable
amount of wealth through any alternative investment. As I travel to give
talks throughout the United States and throughout the world, the people
I meet generally tell me the same thing. They know many who have profited
big in property. They know few (or none) who have scored big by
investing in stocks, bonds, or commodities.
As you will see as you continue through this book, the total returns
available today from real estate still greatly exceed other investments.
Without a doubt, investor demand will remain strong—which will continue
to push property prices higher. In other words, the investment climate
in real estate is evolving just as I predicted in earlier editions of this
book.
Here’s my reasoning: Nearly everyone now realizes that the United
States, Japan, the UK and Continental Europe face an emerging age wave
of seniors. Increasingly, these forthcoming seniors understand that neither
government social security programs nor corporate pensions can possibly
provide them the income (and money for medical care) that they will need
to enjoy a prosperous (or even a comfortable) retirement.
Likewise, a growing number of age wave investors no longer listen
to those 403(k)/IRA fairy tales that narrated a happy ending for all who
would send Wall Street a few hundred dollars a month. In response to
their recent wake-up call, investors have kicked off a “frantic search for
yield” as the New York Times recently put it.
To accumulate the wealth they need and to make up for the money they
lost in stocks, tens of millions of age wave investors need a safe, inflation-protected
after-tax yield of 12 to 15 percent per year (or more). At present, only
real estate offers realistic opportunities to achieve such results.
In the third edition of this book (2000), I made the following analysis
and prediction:
All types of investing present more difficulties today. And
no doubt, investing will become more difficult in the future.Too many people with money are chasing after too few good
investment opportunities. Tens of millions of us expect both
longevity and prosperity. How will we all succeed? We won’t.
We can’t.
Why won’t we? Why can’t we? Because as I then pointed out, there’s
“not enough money to fund the idealistic hopes and dreams of everyone
… [consequently] property prices will continue to escalate and cash yields
will continue to fall.” In their scramble for retirement income (i.e., cash
yield), age wavers will buy property.
For those 50-plus million age wavers who need an inflationprotected
source of income (as well as inflation-protected asset values),
no investment beats property. Even at today’s “high” price, and “low”
rental yields, property produces much more income per dollar of investment
than stocks, bonds, or annuities. If you were to ask, “In general, will
property prove as profitable during the next 10 years?” I would answer,
“Probably not.”
But that’s not the right question. Instead you should ask, “In general,
will income properties offer investors higher returns with lower risk
than any other investment?” In response to that question, I would answer,
“Absolutely.”
Here’s why: Today nearly anywhere in the U.S. (yes, even California)
you can find income properties that provide unleveraged net rental
yields of 6.0 to 7.5 percent. In lower-priced areas of the country, you can
find net rental yields that climb above 12 percent.
Yet rental yield reveals only a small part of the story. To calculate
your property’s total returns, add to the rental yield the gains you will
receive from leverage (financing your investment), amortization (paying
off the mortgage with rent collections), inflation (a rise in consumer
prices; i.e., the CPI), appreciation (price increases that result when
demand overwhelms supply—as we will continue to observe), value
creation (property improvements, more effective management), buying
below-market and tax shelter (1031 exchange, depreciation, tax credits).
When you sum these individual sources of return you will achieve
a total annual yield of 15 percent (or more). When you educate yourself
through books, seminars, and market research, you can earn even bigger
gains. When you enhance your knowledge, you will learn how to find
and/or negotiate bargain prices. You will learn how to recognize those
neighborhoods and cities that are poised for rapid appreciation. You will
learn to improve dramatically the use(s), management, and appearance of
your properties. In doing so, you will collect higher rents and experience
fewer vacancies.
Without a doubt, you can still outperform other investments with
real estate because the property market in general offers greater annual
cash yields. More importantly, you can boost your rewards from property
through education, enterprise, intelligence, market strategy, and creativity.
You will not find similar opportunities with stocks, bonds, and annuities.
Yet no two property investors need travel the same path at the same
speed. You can adopt tactics and strategies that fit your goals, talents,
time, and financial capabilities.
You can choose to invest in net-leased commercial properties and
essentially put your investments on automatic pilot. You can spend evenings
and weekends fixing and flipping. You can buy a fourplex, move
into one of the units, and simply let your tenants pay for your home. You
can actively pursue foreclosures and REOs. You can convert apartments
to condos or perhaps houses to offices. With real estate, you choose from
these approaches or dozens of others. In this book, “investing in real
estate” refers to an enticing range of profitable possibilities.
No matter what situation you currently occupy; no matter how little
(or how much) time, cash, or effort you wish to invest; no matter where
you live; you can surely put together a property plan that when executed
with thought will lead to financial independence—a financial independence
that not only offers material rewards but, more importantly, provides
the life you want to live.
In Chapter 1, I contrast real estate to stocks, bonds, and annuities.
Yet please realize that I do not mount this review merely to persuade you
to invest in real estate. Rather, I do so to emphasize that because real estate
currently excels relative to other investments, more and more people want
to own property. And most of us who currently own plan to own more.
Even people who aren’t particularly interested in property want to invest
if for no other reason than to diversify away from paper assets into real
assets.
We are experiencing large gains in property prices because—contrary
to media madness—investment property remains undervalued relative to
its competitive alternatives. Be aware. When I say investment property, I
do not mean single-family houses or condos that sell for $1.5 million and
bring in $3,000 a month in rents. I am referring to properties that yield a
positive cash flow when purchased using typically available financing. Or
alternatively, properties that you can buy at a discounted price; properties
that stand out as prime candidates for improvement; properties in undervalued
locations; and properties that you can convert to a more profitable
use.
Every type of investment goes through cycles of short-term setbacks.
So I make no firm predictions about the next six months or even the next
several years. Even though I expect the bull market in property to roar
on (for the reasons stated), I realize that an economic downturn, a sharp
spike in interest rates, or perhaps overbuilding (in some markets) can create
a temporary stall. (Again, too, I emphasize that I refer to investment
[cash flow] properties that bring in rents that reasonably relate to the price
of the property. Certainly, many coastal metro area condos, houses, and
small apartment buildings fall short on this criterion.)
Even though property prices may hit a downturn, my personal
wealth remains predominantly invested in property. Why? Because as I
look five, ten, fifteen, or twenty years into the future, my properties—and
your properties too, if you apply the knowledge and ideas you’ll learn
throughout this book—will have yielded superlative total returns. Start
now and like most long-term property investors, you will enjoy a lifetime
of financial freedom and investment security that only property can provide.
Questions or comments? Contact me at gary@garyeldred.com. For
more about how to invest profitably in today’s market, go to garyeldred.
com.
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