Pros and Cons of Investment Property

Investment property isn't just about cash flow projections and planning. The investor must analyze a property carefully before purchasing, then manage it effectively. If successful (and lucky), one can become quite profitable from real estate investments. After all, The most significant asset of most families is the equity in their homes.

 

Advantages of Investing in Real Estate

High Leverage (the use of borrowed money with the intent to increase the investor's return on the cash invested). Few other investments offer the high leverage real estate does. Whereas stocks and bonds typically require at least a 50 percent down payment, most real estate investments can be made with 25 percent down payments or less.

Good returns. Many cautious and keen investors yield great returns, often exceeding 20 percent.

Income tax shelter. Most investments (ex: bonds, stocks, and mutual funds) require that investors pay taxes on all current income (dividends). Real estate investments often provide tax-deferred cash flows, primarily due to cost recovery deductions (depreciation). This allows investors to avoid paying taxes on cash flow until they sell the property. 

More personal control.  The purchase of real estate gives an investor control over the investment's operation and management. Even if the investor hires a property manager, the manager reports to the investor.

Disadvantages of Investing in Real Estate

Management time. Consistent management of an income property's operations takes time. The investor should achieve a higher return on investment to compensate for this.

High capital requirements. Investors need funds to acquire the property and must have reserve funds available to make renovations or cover unexpected events. If vacancy rates are high, investors may have trouble selling the property and may need to put more money into it to pay its operating costs and debt service until more stable ground is reached.

Poor liquidity. Investment real estate is a complex purchase, involving land-use requirements, environmental audits, maintenance inspections, lease reviews, and new financing. A seller must understand that it could be a year or more after listing the property on the market before closing a sale, even under normal or good market conditions. 

Personal stress. Property management requires personal interaction with tenants, unless an owner's properties are large or profitable enough to hire a manager. When the mortgage payment is due, slow-paying tenants can be a burden. Tenant complaints take time and people skills to resolve. If tenants leave a property in poor condition when they move out, the investor must restore the premises. Eviction is sometimes necessary and is a stressor to all involved.

High risk. Overbuilding in the market, causing high competition and lower rents, could lead to failure. Environmental laws may require costly retrofitting, or a large employer may relocate, resulting in widespread unemployment. This type of risk--dynamic risk--is not covered by insurance.