A Young Reader Asks, Should I Start Investing in Real Estate?
Someone starting out asked whether to buy a rental property once he’d saved for a down payment.
It’s a great question touching on important money concepts.
The Real Challenge
To start, saving your initial capital is harder than figuring out how to invest it. Charlie Munger taught us this long ago.
It’s a b—-, but you gotta do it,” Munger said. “I don’t care what you have to do — if it means walking everywhere and not eating anything that wasn’t purchased with a coupon, find a way to get your hands on $100,000.
Yahoo Finance
$100,000 is arbitrary, but when you’re starting out, building capital should be your focus, which means increasing your income and resisting the urge to spend it. And maybe I’m just an old grouch, but it’s harder for young people to do when their phone provide countless temptations: shopping apps, food delivery, on-demand cars, and online gambling.
So, how much can you make, how much can you save without missing out, and what expenses can you cut? With that determined, how long until you hit your savings goal?
If you like the answer, great.
If you don’t, how will you grow your income and cut your expenses? When young it’s easier to boost income, but don’t forget that spent money can’t grow.
Let’s say you’re spending $150 a month sports betting, another $100 a month on Zyn or an extra night out, and $50 in impulse Door Dash orders. That’s $300 a month. Five years from now, you’re out $18,000. If you had invested that and earned 8%, you’re out $22,000. And what did you give up?
Opportunity Cost
OK, but how about investing in real estate once you can?
This is where opportunity cost joins the party. If you find something that prices out to deliver a strong long-term return, do it. If not, don’t.
Back to Munger.
You earned this capital through hard work, sacrifice, and discipline, so you owe it to yourself to target a strong investment return.
In the real world, you uncover an opportunity, and then you compare other opportunities with that. And you only invest in the most attractive opportunities. That’s your opportunity cost…It’s your alternatives that matter.
Tren Griffin, “A Dozen Things I’ve Learned from Charlie Munger About Capital Allocation
Real Estate Investing
Applying that here, if you find a rental property, model it out, and the return is strong compared to what you could get in stocks (another accessible way to grow capital), great.
If it’s an environment like this where mortgage rates are high, prices haven’t come down, and home insurance is nuts, put your capital to work elsewhere.
I’d personally prefer to see at least 10% returns in a model assuming 10% vacancy, a 1% maintenance budget, and prices and expenses increasing by inflation. And bear in mind you’ll probably need a mortgage to get there.
Looking for a Wealth Building Approach?
My three-part framework can help.