How to lose 110% of your money in real estate in 2 years: A happy ending with a few morals
December 25, 2008
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If you subscribed to my twitter feed (which is a a must), then you were likely confused by my tweet from earlier today in which I simply said "free!!!!". That tweet was a celebration of having sold an investment property (a 4-family rental property) two days previously. I lost approximately 110% of my equity investment in the property. This is in addition to the money I lost when I sold my house at the beginning of 2008. And yet I couldn't be happier. Why? Because real estate has not bottomed and prices will continue to fall. Furthermore, over the next couple years, even after the bottom in housing, prices will remain stagnant. So while I lost a lot of money, I have avoided losing more. And don't cry for me--I've been doing quite well in my day job, so my financial situation is the same as it was before I lost all that money in real estate.
Here are some lessons you should draw from my misfortune:
1. If you have a reason to sell something (whether real estate or stocks), sell it quick and be done with it. Don't hope prices will rebound. I had very good reasons for selling my property this year (even outside of slumping real estate prices); if I had gotten aggressive in pricing earlier I could have sold it for more money, reducing my loss to maybe 95%. When you buy a stock, you should have an idea what would make you sell it; if that happens, sell it!
2. Don't own real estate unless you are 99% sure that you will live in an area at least 10 years. This is a high hurdle, but owning real estate will reduce your mobility, impairing your ability to move to get a better job, and the costs of buying and selling mean that if prices are stagnant (let alone falling) you will not do well to buy. The common wisdom I was told was that living in an area 5 years was enough, and that is way too short of a time to plan on owning one piece of RE.
3. If you do everything right and yet buy at a cyclical peak, you will lose. I did everything right in my 4-flat investment, except that I bought at a cyclical peak. While I was cash-flow positive from the beginning, got good tenants, and increased rents, I bought at a capitalization rate of about 8% and sold at a cap rate of maybe 14% (think of it as like an interest rate, the inverse of a P/E). Likewise with stocks -- if you bought a year ago you lost because of the fall in P/E ratios, even for stocks with stable earnings.
4.Consider non-obvious risks and costs. Costs with real estate include your time. Risks include getting sued, regulatory risk (I lost some money due to variations in my income over the period in time I owned the rental property and how that affected my tax situation). For those of you in stocks, think about all the time you spend investigating them and whether that is worth it. Please note that I am a full-time day-trader and financial blogger and I do not believe it is worth it for me to invest in individual stocks (for investment, I only buy broad-based ETFs, currently VTI and VEU).
5. Always consider other investments. Right now, you can buy solid, investment grade corporate bonds at yields of 6% to 7%. The ETF LQD was yielding 7% last I checked. In this environment why buy real estate when you can get great returns from bonds with little risk (assuming you are diversified). I bought some JNK (junk bond ETF) a week or two ago and believe that most corporate bonds will do very well henceforth. When you consider any investment, consider whether the alternatives are more attractive.
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