I am a ruthless competitor.
I just prefer not to show it – if I can secretly work harder than anyone else, I will.
Some people make small-talk during Scrabble. I’m constantly thinking through possibilities and just nodding along to whatever you are saying to me. “Ya, uh huh, sure”.
When it comes to investing, I am also going to put in more effort than the average person. To me the average person is lazy and accepts poor results. See the mutual fund industry for more info.
But effort takes time and time is non-renewable. So maybe I shouldn’t put in too much effort… ?
Investors Talk Risk-Reward
When investing there is a trade off between potential return and how risky it is.
As an example, an established company like Coca-Cola isn’t going away any time soon. If you invest in it, you can be pretty certain the company will keep on chugging along as it has for the last hundred years.
If your friend’s cousin has an iPhone app company that is running out of money and needs investors, run for the hills. Well, unless they make it worth your while. Since there is a decent likelihood the company will implode, they will offer you significant upside for investing.
With potential for downside losses comes potential for upside profits. Otherwise you would just go with the sure thing every time.
Rental Properties Risk-Reward
With rental properties there can certainly be a risk-reward component. You can invest in a Manhattan sky-rise condo, rent it out, and pray the value increases.
I call that gambling.
Is there potential for huge returns? Yes, but it isn’t worth it because you can lose everything.
If the market softens, your tenant will move out because rents are lower elsewhere. It already didn’t quite provide enough cash flow to cover your monthly expenses – now it is vacant and will rent at a lower price. It bleeds money every month and if your day job can’t support it, you can’t even sell because it is underwater. So bankruptcy is the only option.
This scenario might be unlikely, but it isn’t worth the risk because you can make excellent money in rentals without it.
I prefer to take the most conservative approach possible, investing in low-cost cities with excellent rental income. The cash flow provides enough cushion to wait out any downturn. I use my decades long timeline to my advantage. The leverage on these low risk rentals makes it a homerun.
We don’t have to worry about the risk-reward trade off since we are going with the most conservative properties.
Instead real estate investing should be considered an effort-reward trade off.
There are an incredible number of ways to be a “real estate investor”. That can mean speculating on Manhattan condos or flipping homes in your suburb. Those two have almost nothing in common.
When it comes to rental properties, there are still many ways to go about it. You can take care of everything end -to-end, finding a distressed property, rehabbing it yourself, and showing it to prospective tenants. Or you can pay someone to do that for you.
It shouldn’t surprise you that if you do less work, you can expect less returns. The extreme example of this is investing in real estate through a REIT (real estate investment trust). You do no work, purchase it just like a stock, and get a 8% to 12% return.
If you buy turnkey properties like I do, you put in significantly more work. You have to build relationships, perform due-diligence, and muddle through legalese. But once the property is purchased, the property manager makes it so you average less than an hour spent per month. You can expect a 20% to 30% return when you factor in all 5 components.
If you take on more responsibility, you can certainly up your returns: less middle-men make a profit off you. You can be the property manager for an extra hundred dollars a month. You can do the wholesaling to save thousands off the purchase price. You can schlep your toolbox over there on weekends to rehab it.
But is the reward worth the effort?
Don’t Forget to Evaluate the Effort Involved
You might hear statements like “I made ten thousand dollars flipping a house.” How much work went into it? Were you rehabbing yourself on weekends or dealing with pain-in-the-butt contractors? How many dozens of properties did you look at before your offer was finally accepted?
They want to tell you the good part and leave out the work required.
It’s similar for people who save money by being their own property manager. You might hear “I get an infinite return by managing it myself” because they put in no additional money. But you know better – putting in time and effort is just another form of the same thing.
This helps keep me grounded. I am not doing as well in real estate investing as plenty of people. It is easy to hear their success stories and feel like I’m not doing enough. It is natural to want more.
But at what cost? What is the effort required? How can I put in 20% of the effort and get 80% of the results?
For me the answer is purchasing buy-and-hold rental properties from out-of-state turnkey operators who do most of the work. I’m still able to get a 29% annual return and that’s good enough for me!