Investing in real estate is a hot topic in 2022 with a booming market for housing prices. However, deciding to “invest in real estate” is only the beginning. Many options exist, from low to high risk and low to high effort. Choosing the right one for you is critical.
Money expert Clark Howard, a long-time real estate investor, thinks most people who want to invest in real estate should focus on REIT index funds or ETFs.
Why is that Clark's preference for the average investor? And what are some of the other common ways to invest in real estate?
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Clark’s Investment Philosophy and Real Estate
Clark’s general investing principles are time-tested, popular — and, well, boring.
The last adjective is one that Clark wears with pride as he emphasizes limiting fees, minimizing risk, diversifying and taking a long-term approach.
If you have to pick just one of those ideas that will have the greatest impact on your wealth over decades, it may be the fees you pay.
Fees present tricky traps to retail investors. Paying them can be an afterthought when you decide where and how to invest your money. It takes some knowledge to understand what are respectable fee rates for various types of investments. And sometimes we drool over returns — or potential returns — at the expense of ignoring or minimizing fees.
There exists an abundance of YouTube advertisements from clever marketers telling you how much money they’ve made in real estate, claiming to teach you for a fee. (Nevermind whether they’ve really been that successful, it’s hard to believe they all want to give away their secrets.)
People who have spent most of their lives online are particularly bombarded with ads for exciting, lucrative real estate opportunities through crowdfunding sites.
All that messaging elevates the potential to strike it rich. It also glosses over the practicality of taking fees and costs into account when thinking about your potential ROI.
Perspective on Clark’s Investing Advice
There’s at least one caveat to Clark’s investment pillars. He generally gives money advice via his podcast to a large, faceless audience. So he caters his advice toward the simplest solutions that will help the most people.
Clark acknowledges that they aren’t always the optimal possible options for every single person — particularly the wealthy: those who are outliers in terms of risk tolerance and are already comfortable managing a complex portfolio.
But without knowing your specific goals, family circumstances, assets, debts, income and other factors, Clark says that there’s a clear winner in terms of the best way to invest in real estate for most people.
Why Clark Recommends REIT Index Funds and ETFs for Real Estate Investing
For most people, Clark thinks REIT index funds or real estate-centric ETFs are the way to go when it comes to real estate investing.
“There are choices you can go into [that are] ultra low cost where you diversify into little pieces of all different kinds of real estate with the ability to get in and get out at will,” Clark says.
REIT stands for Real Estate Investment Trust. A REIT has some parallels with a mutual fund. It trades like a public stock, which makes it highly liquid. The diversity and focus within each REIT varies — although like index funds, some of the most popular REITs are highly diversified and fairly low cost.
There are some nuances and rules around REITs. But the main point is there's an abundance of low-cost, highly liquid, well-diversified real estate REITs that you can invest in, even for tiny amounts of money.
Real estate ETFs, or exchange-traded funds, exhibit essentially the same characteristics.
These real estate investing options are not as sexy as the “get rich quick in real estate” schemes. You’ll have less control. Your chances of generating an outsized return and suddenly multiplying your investment by many times are slim.
Also, some REIT or ETF options are concentrated in very few properties or a narrow type of real estate even though there are many great options that match the characteristics that Clark evangelizes.
The results aren't guaranteed. But according to Nariet's index of publicly-traded REITs, they outperformed with 11.6% annual returns for the 20-year period ending December 2019 compared to 6.1% for the S&P 500.
The Potential Problems With Other Types of Real Estate Investing
The downsides you’ll encounter with other types of real estate investing differ depending on the option.
And there are plenty of options. Maybe you’re extending yourself to buy the nicest house you can afford to live in, dabbling in real estate crowdfunding sites, investing in short-term rental properties or buying up commercial buildings.
In any case, here are some of the potential issues you’ll face if you stray from Clark’s best solutions for the masses:
- High fees: As an example, some of the crowdfunding marketing I referenced earlier focuses on the potential for "lucrative" returns. However, these sites tend to "bury the lede," to borrow from newspaper parlance. These companies exist to make a profit off of your investments. That's why they spend so much money on attractive, emotion-based advertisements. They often hide the fees they charge deep in their terms of service — or bury them inside text on a hard-to-find section of the website's FAQs.
- Illiquid investments: Whether you're giving your money to a third party to invest for you, buying a house or building your own commercial property, recouping the liquid value of your home is often not possible, at least not without paying a money-burning price.
- Lack of diversity: Want to own real estate? The average home price in the United States was approximately $400,000 as of February. Buying in a nice neighborhood in a bigger city? You can expect to spend much more. If your net worth isn't in the millions of dollars, even a single property can represent an outsized percentage of your portfolio. That creates risk, at least in the form of opportunity cost.
- Uncertain legal framework: Local neighborhoods and cities have been disallowing certain types of short-term rentals recently. Airbnb has even banned parties from taking place. If you buy a property intending to use it as a short-term rental, keep in mind that the legal landscape could shift.
- Unattractive market prices and mortgage rates: Home prices have reached exorbitant levels in 2022. Although Clark does not anticipate any sort of significant crash due to supply and demand dynamics, he has advised some would-be buyers to consider waiting for a softening of the market. Thanks to interest rate hikes by the Federal Reserve, the average 30-year fixed mortgage rose from 2.65% in January 2021 to 5.81% just a few weeks ago.
- Large upfront costs and ongoing expenses: Closing costs, realtor fees, down payments, inspections, permits, building materials, property taxes, interest on loans, maintenance, insurance premiums, utilities and homeowner's association dues are just a few of the many hidden expenses that you can incur when you get involved with real estate.
- Management skills: If you're operating a short-term rental business or you're leasing a commercial building, you'll need to manage the property. That includes ensuring payment from tenants, troubleshooting any maintenance issues, cleaning the place in between renters and potentially having to market your property.
It’s important to make investment decisions based on substance and logic rather than as an emotional response to marketing tactics or dreams of getting rich fast.
That holds true for real estate investing as well.
Clark’s real estate investing advice for most people is to focus on finding a low-cost, well-diversified REIT or ETF.
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