This article was written by a colleague and former classmate, Ben A. Holter, PharmD, RPh, MBA. Ben is a 2008 graduate of Ohio Northern University and completed his MBA at Ohio University in 2013. He is currently the Pharmacy Manager at Shrivers Pharmacy in Nelsonville, OH and a managing member of Orion Ventures LLC and Cragganmore Investments LLC. These companies are based in Athens, Ohio and focus on the acquisition, development, and leasing/selling of both residential and commercial real estate (www.athensoh.com). If you have any questions about this article, feel free to contact Ben directly at [email protected].
Following the sage advice of Your Financial Pharmacist, let’s assume you are on track with your financial plan–paying down or paying off debt, creating and following a budget, investing in your employer’s retirement plan, emergency fund in place…check! Well done, you’ve laid the foundation for a strong financial future. Now it’s time to start thinking about diversifying your investments outside (and inside) of the traditional retirement plan. My preferred way to accomplish this goal is through real estate. Whether you realize it or not, most of us will become real estate investors with the purchase of our first home. That may be enough exposure for some of us based on our goals and comfort level, but I would encourage you to consider other ways to add real estate to your portfolio.
“Fixer Upper”, “Tiny House Hunters”, “Flip or Flop”, “Property Brothers”…if you’ve channel surfed through satellite TV in the past decade you’ve likely been inundated by these and many other real estate based reality TV shows. It seems that while you were off racking up student loan debt and limping through organic chemistry, the rest of the world has been getting rich buying and selling real estate. Oh, you haven’t heard? It’s simple! Buy low, renovate, sell high, and get rich…what could go wrong? Hang tight, we’ll get there—but despite the hype, I believe real estate has an important role in helping to diversify your investment portfolio. Although it may not be as exciting, there are many ways to invest that don’t involve “flipping” houses or even direct ownership, yet can still provide great returns while mitigating your overall risk.
Before delving into the different ways to invest in real estate, there are a few basic questions you need to ask yourself:
- Do I want to actively manage a property/properties or be a passive investor?
- What is my investment strategy? Am I looking to “flip” properties for a short-term profit or make long-term investments?
- How much time and money do I want to invest and how much risk am I willing to assume?
How you answer these questions will help you decide if real estate investing is right for you and which types of investments suit your lifestyle and fit into your overall plan.
Physical Property – Residential
Houses, condos, duplexes, multi-family units, and apartments are common examples of residential property. Owning and acquiring residential properties is relatively easy as markets are established and financing to qualified buyers is readily available. While the amount of active management required for owning physical property varies based on the type of property owned, it is rarely passive unless owned with partners who take on the management role. Repairs, maintenance, rent collection, vacancy, property taxes, rental permits, compliance with code, and insurance are only a few of the things you will need to think about as a property owner. That said, residential property is the place to start if you decide empire building is right for you…but don’t forget—when the plumbing backs up, the pipes burst, or the furnace dies, you’re the one who gets the call.
It’s also worth noting that flipping residential property tends to be the focus of the aforementioned reality TV craze. Having been personally involved in multiple flips, I promise it is not as easy as portrayed on television and I much prefer long-term rental properties. While flips can be very profitable, they also carry a substantial amount of risk for the inexperienced investor. The takeaway here is to diligently research any potential project and have a structured plan with a substantial margin for error in your cost and sale estimates if you decide to take the leap.
Pros:
- Buy/sell process is relatively simple and straightforward
- Smaller investment required to get started
- Demand for rentals is typically high unless in a saturated market
- May appreciate in value if well maintained and in a stable market
- Buying undervalued, foreclosure, and/or short-sale properties can offer an outstanding return on investment
Cons:
- Renting or flipping residential properties require active management and is typically NOT a passive investment
- Flipping properties can carry a great deal of risk
- Repairs, maintenance, deadbeat tenants
- Leases tend to be for shorter durations (1 year typically)
- No cash flow during periods of vacancy
- Housing bubbles can and do exist…remember 2008?
Physical Property – Commercial
Office, retail, and industrial buildings are all considered commercial real estate. The complexities and higher cost of owning and leasing commercial real estate likely make this investment choice a difficult one for the novice investor. However, there is a good chance that many of you who have an interest in entrepreneurship may eventually own commercial real estate in the form of an independent pharmacy or other business venture. If this opportunity presents, be sure to work with a real estate agent or attorney who has experience in commercial real estate transactions.
Pros:
- Commercial properties can command premium lease rates
- While investment is typically larger, so is the return
- Leases are typically long term (3 years or longer) and place most of the maintenance burden on the tenant
Cons:
- Large initial investment required and financing is more difficult to acquire than residential
- Leases are complex
- If building is vacant, may require significant cash flow to cover carrying costs until another tenant can be found
Alternative Investments – REITs
Real estate investment trusts (REITs) are unique investment vehicles that allow you to invest in various segments of the real estate market without actually owning the physical properties. REITs are traded like stocks or mutual funds and often times are listed as options in employer retirement plans. Essentially, REITs use investor money to purchase/develop real estate and after paying management costs, must legally return at least 90% of the profits to investors in the form of a cash dividend. This allows investors to have exposure to the real estate market without the burden of active management and risk of owning individual properties. I personally own REIT funds in my 401k and would strongly encourage you to consider allotting at least 5% of your portfolio to REITs if your plan offers the option and your financial advisor approves.
Pros:
- Professionally managed to offer investors a passive real estate investment
- Diversification of investment portfolio
- Ability to purchase REITs that focus on different projects such as office buildings, apartments, shopping malls, etc.
- Easy to purchase through a broker, online brokerage such as E-Trade, or often listed as an option in your employer’s retirement plan
- Easy to liquidate since they are traded on the open market
- In addition to dividend payouts, the value of the stocks/funds may also appreciate in value
Cons:
- Many of the risks associated with owning real estate still apply (economic downturn, vacancy, etc.)
- Relying on REIT fund managers to make competent decisions
- If not held in a retirement account, dividends will be subject to tax (discuss with your accountant)
- Rising interest rates can decrease profits
Alternative Investments – Crowdfunding
Crowdfunding is no longer limited to Kickstarter and Go Fund Me. Using a similar model to these sites, investors used crowdfunding real estate platforms such as realtyshares.com to pour nearly $500 million into real estate projects in 2015. While these sites may be the new hype in real estate investing, the model has yet to be fully vetted and my advice is to take a “wait and see” approach.
Pros:
- Ability to invest small increments of money in hand picked projects
- Can invest in development projects that are important to you
- Like REITs, these are passive investments
Cons:
- Currently over 100 different websites for real estate crowdfunding, many will undoubtedly fail
- Long-term viability is unknown, investment model has only been legal for about 3 years
- Non-liquid investment that may be difficult to sell quickly
Conclusion
My hope with this article is to give you a brief overview of potential investment options and perhaps pique your interest into the world of real estate. Owning physical property can be a great wealth-building tool if you’re comfortable with the risks and obligations. If not, REITs are an easy investment vehicle to diversify your portfolio by gaining exposure to the real estate market without getting 3 am calls about faulty plumbing. Ultimately, if you decide to incorporate real estate into your plan there is an option for everyone. Best of luck in your financial adventures and feel free to reach out if I can offer advice or answer your questions!
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