4 Questions to Ask Before Investing in Real Estate

By Tammy Trenta, MBA, CFP, CTC, CEXP; Founder and CEO - Family Financial

This is about to get personal. The investment decisions we make are rarely driven by “just business.” Logic dictates that money matters and emotions should maintain a church and state-like separation. But human nature ensures the two remain kissing cousins.

Investing in real estate is considered by many to be the pinnacle of the American dream, but few consider how emotions play a role. To be successful, we must understand our emotions and the backstories that fuel them - and how they quietly point us in a particular direction.

As a wealth advisor, working with clients includes evaluating their real estate investments. I often serve as a sounding board, helping clients walk through their story so they can articulate what’s really important to them. This helps them understand the motivations behind very important real estate decisions. When the emotional component of a decision is uncovered, it helps them affirm their choice, or realize it’s time to change direction. 

1. Are my emotions in check?

Real estate is often the largest purchase we make in our lives, so the stakes are high. This is an interesting time in the market when housing values have skyrocketed. Many clients want to buy - sometimes from a fear of missing out, or from a desire to create wealth quickly. But fear and greed are emotions that drive financial decisions that aren’t always in our best interest.

During my childhood, my parents lost everything because of over-leveraged real estate investments. That experience permeated my subconscious. After going through the process of understanding how their loss affected me -and then fully “owning” those emotions - logic entered the chat. Objectively, I realized fear was clouding my vision. I’ve since embraced the idea of real estate investing in a thoughtful, strategic manner.

Whether a “fear of,” or a “fear to” - it’s critical to recognize, examine, and own the emotion.

2. Is it a need or a want? 

Separating needs and wants is important when considering purchasing a new primary residence. Many look at homeownership as the American dream and jump into a purchase without realizing a house can be a liability. 

A common pitfall is believing that renting is “throwing money away.” Of course, each situation is unique. If you have 4 children in a 2-bedroom apartment, and a mortgage payment will be similar to your rent payment, it could make logical sense to buy. But from an investment perspective, the upside potential matters. Historically, real estate has gone up about 4% every year. Unless there is an income component, you must ask yourself: what am I giving up to earn 4%?

Another common pitfall is accepting a mortgage just because you qualify for one. I have a client whose business is booming and wanted to purchase a larger home. He qualified for a mortgage loan $1MM higher than what he’d originally considered. But closing on the deal meant selling all of his investments that have been earning him money. His version of the dream turned into an instant liability by compromising his goal of achieving financial independence at age 55 and requiring him to work for another 10 years.

3. What is the “Opportunity Cost?”

Liquid assets are an important consideration for your investment portfolio. If you need to access cash tomorrow, you can do so while the rest continues to grow. But real estate is never liquid - so you’ll need to justify tying up the money. 

There are people who invest in real estate, but have negative cash flow – meaning it costs them more to maintain than the property generates in rent. They do this in the “hope” that someday it will be worth more. But this is flawed thinking; when investing, appreciation and income are important. Always consider other possible uses for your capital, and the “opportunity cost” of any expenses you take on.

4. Do the numbers make sense?

The larger the real estate purchase, the more the numbers may surprise you.

I know of a popular beach town where the average home costs $2MM. Together, the loan payment, interest, property tax and insurance equates to a housing payment of over $10,000 per month - in addition to a hefty $400,000 down payment. 

Let’s say you’re in the 50% tax bracket. Of the $10,000 monthly payment, you’ll save $1,400 per month off of your tax bill, for a net housing expense of $8,600 per month.

In today’s market, rentals of similar properties are going for $7,000-$8,000.

IRS deductions are limited to the first $750,000 of mortgage interest. Insurance isn’t deductible, and you may have little to no no deduction for property tax. Any housing payment exceeding this mortgage interest cap is like throwing money away. The only amount retained is the tiny piece of equity embedded in that housing payment. 

And interest rates on 30-year fixed loans have doubled since last year, so the housing market may soon slow down. With the average homeowner remaining in their home for less than eight years, could money be leveraged more efficiently than in a 30-year mortgage?

Real estate purchases require forward-thinking. By examining your motives and owning the reasons behind your choices, you can feel even more confident that you’re on the right path to your version of the American dream.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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