We all know that the best way to make money grow is to invest — but the stock market can be a scary, unpredictable beast to those who don’t have experience with it. That’s why many choose to invest in real estate — whether it’s for your own home’s equity, buying homes to flip them, or generating rental income. Since real estate is a physical, tangible thing, the illusion is created that it’s controllable. But what happens if you end up not being able to make a mortgage payment, if no one buys the flipped home, or you can’t find a renter? Here are the pros and cons of choosing real estate so you can decide for yourself if it’s truly an investment … or a liability.
Many people view their own home as a real estate investment. We all need a place to live in anyway, so it just makes sense, right? It depends. It only makes sense if you’re truly financially ready for homeownership. What does that mean, exactly? For starters, aside from having sufficient savings for a down payment and an emergency fund for repairs, you’ll have a mortgage payment and taxes to deal with. Then, there’s the possibility that you signed on for a mortgage with a variable interest rate. If that’s the case, then be sure to have a contingency plan (read: another savings account with funds to cover an increased payment) for when your rates inevitably go up. Otherwise, you may have a liability on your hands.
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So let’s look at how you can pick a home that is good investment material. If you purchase a home in an area that has generally increased in value over the years (or shows promise to grow in coming years), then you could be in good shape for your home’s value to increase as well. Take a look at things like the school district, local businesses, public services, crime reports and growth data. If you’re buying in a well-established neighborhood, then that could be a more solid bet with a slower (but more steady) growth rate. If it’s an up-and-coming neighborhood, then you’re taking a risk but could stand to make a lot. Like any other investment, it all comes down to your tolerance for risk (and, in this case, where you’d actually want to live for potentially the next 10 to 30 years).
Another method of real estate investment is “flipping.” To flip a house means buying a house that needs a lot of repairs and improvements, doing the repairs yourself or paying to have them done, and then selling it for more than the purchase price and repairs combined. If you are an expert at home repair and/or home design, then this could be an excellent (although possibly expensive and definitely time-consuming) way to earn extra money. Be careful to choose your neighborhood and timing wisely, just like with your own home. Any money you invest should be money you can afford to lose, since the housing market can fluctuate much faster than you’d expect.
If you’re interested in doing this, but lack the necessary skills, you could pay someone to make the repairs. This does increase the overhead of the investment quite a bit — crunch the numbers so you know what you’d need to spend and how much you’ll have to make on the sale to turn a profit. Try speaking to professionals in your area to get a better idea of whether or not this is a worthwhile investment for you. Of course, you shouldn’t go into debt to make this investment.
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Rental income — whether you are renting out part of your own home or a property that you’ve purchased for that reason — comes with its own set of risks and benefits. If you have a basement or attic apartment you’re not using, it could be a prime opportunity for rental income. The con is that there will be a stranger living in your home, so be sure to carefully screen and choose your tenant. You could invest your money in creating a separate entrance in order to protect your own living space. To make this a safer investment, be sure that you don’t purchase a home above what you an afford with a plan to subsidize part of the mortgage payment with rental income. At that point, you might be taking too great of a risk if you don’t find a renter or your renter doesn’t pay — which could cause you to default on your mortgage. Keeping within your budget without considering rental income will, of course, make that income all the more beneficial to you.
If you’ve purchased a home to rent it out, the same risk of default applies if your renter falls through or if you can’t find one. You’ll also have to accommodate for inevitable repair costs and updating costs to keep the home in living and sellable condition. So while this can be another great way to earn money (especially if you choose a home in a neighborhood renters want to live in — often young professionals) it’s still a risk and, ideally, not one for which you should take out a mortgage.
At the end of the day, all three of these could be solid options for investment if you’re prepared for whatever problems could arise. As always, you’ll want to make sure your own financial house is in order before you get involved in any kind of significant real estate commitments. That means staying away from other types of debt (like credit card debt) and ensuring your income exceeds expenses. And remember, home values are affected by the general state of the economy, the population growth rate and the fiscal health of the neighborhood. Make sure that you’re playing to your strengths in this decision so you don’t take on more than you can handle.
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Image: Siri Stafford