Should You Invest in Real Estate? Part 2 -- Fundamentals of Investing

I want to talk more about the actual execution of the strategy, Nolan. So I know a lot of people talk about real estate. That's passive income, easy. You know, you're just drawing some income off of rent that's coming in and building up an asset. But let's talk about the actual execution of the strategy. Nolan, talk about what it's like to own some rental properties and what can happen from the landlord point of view.

I know we hear these nightmare stories about plumbing breaking in the middle of winter and water in the basement and things. I haven't run into that in my experience with clients very often being landlords. But here's what I do run into. Even if the property is being managed by a third party, so a real estate firm or some management company, If you're the owner, it's not as passive as we would like. When things break, the management company still has to notify us and get our approval before they do the repair. If there's a vacancy, you know, somebody moved out, they didn't leave our home in the best condition, then we still have to be notified. We have to arrange and pay for the repairs, and we probably want to do some sort of inspection. Ourself. If there is a vacancy, you know, it's been a month, it's been two, we're looking for new tenants, we probably want to be informed. If we had a bad tenant before, it's likely we may want to be involved in the selection process with the new tenant because we're somewhat nervous. So if that's the case, you could get into a nerve-wracking situation where we've had a vacancy longer than we want it, and we may not have the best tenant applicants. What do we do? Do we continue to keep piling up negative months of cash flow, or do we let somebody in who may not be the ideal candidate, thus risking further loss on the back end? So the point is, you'll still have management decisions to make. Even though you're not on the ground pushing a button or raking leaves yourself, you still will need to be mentally checked in to this project.

And I'm glad you mentioned— you sort of passed by this point, Nolan, but vacancy. So it'd be ideal if I owned a building and, you know, I had a tenant for a year, that year was up, they left, and then we filled back in the next month with a new tenant. But what is the reality of how that works? Talk about vacancy a little bit.

That's right. So we have a tenant, either the lease came up, the tenant decided not to renew or didn't fulfill the lease obligation, whatever it is. But now we have somebody that's moving out. First thing we need to do is get the place ready and habitable so we can show it to the next potential tenant. So there's a turnaround time. If our lady and family moves out on the first of the month, we're scrambling to get that place in good condition, get our repair people in there so we can show it and start advertising it. Generally, when you get a new tenant, even if you find somebody that afternoon that you think is the ideal tenant, there's still time to get that person approved. You got to do the background credit checks. That person's probably living someplace else. They have to give notice. So it's generally not a— I find you on Monday, you move in on Tuesday with, with properties and people's lives and their possessions. So it's probably going to be some while. So let's say a short turnaround vacancy is one month. It's only vacant one month. And if that's the case, you have a pretty good situation. Now, one, you probably have had to pay some money to renovate the place, you know, to get it ready. Two, you probably had to pay some sort of commission in order for the realtor to bring the person to your place. Generally, the realtor fee is one month of rental. So I had a vacancy for one month, I have some person, but now I have to pay one month commission for the realtor that brought the renter in. So now I'm down 2 months in that month's rent and 10 over 12 is about 80%. So I'm getting 80% of my cash flows for that year, not anywhere near 90 like we modeled when we said you're going to get 5% cash flow.

Okay, so that's good. No, I think the point we're trying to make is, you know, I think people need to really think of what they're, what they're getting into in the real estate marketplace and they need to think about what the hidden costs really are. So when they sit down and model out the numbers, you can't model out 100% occupancy, you can't model out zero maintenance. All those things come with it. With that being said, Nolan, what are some alternatives? Talk about some alternative investment opportunities for folks who are looking for something to do with their cash they have on hand. That's obviously what they're trying to do with real estate is find a good investment for excess cash. So talk about what are those options out there?

Yeah, that's an important point. I don't want to gloss over that, Brian. I think the big distinction is investors who want to be truly passive and who want the best economic return versus those who really actually want to be hands-on. You know, there's a lot of investors that are tinkerers or do-it-yourselfers, and, you know, they like the idea of a new project that they're working on, even if it doesn't pay them, even if they have to pay to do it. So those people, we, we exclude from our, our discussion. We're really talking to our clients. Our clients work a lot, they travel, they have families. Their downtime, they really appreciate the rest and rejuvenation. So they really want to set it and forget it. They want truly a passive investment, something I can write a check, pass off, and whenever I have time in my year or my week, I can pop in and see how it's doing. But it doesn't require any mental energy or effort on my part. With that in the backdrop, let's talk about some passive investments that people can make that we think stack up favorably to real estate. All of these are publicly traded and they trade somewhere on an exchange. That means that there's liquidity. So if I want to buy or sell it any day that the markets are open, I can buy or sell it and turn it into cash very quickly with a ready pool of buyers. The first category, what we're going to talk about is bonds. And bonds are publicly traded. These are loans and obligations that could be issued either by corporations or governments or local municipalities. And they have guarantees. There's a start date and end date and a fixed rate coupon. So that would be the first one to discuss.

Brian, bonds generally return somewhere in the 4 to 6, 7% range. For all these alternatives, we're going to put up kind of what an expected return would be over a 10-year period. So you can get a good sense of what we're looking at. Another alternative, Nolan, is REITs. That's real estate investment trusts. Talk about that.

Yeah, a lot of people when they're doing real estate, you say it's illiquid and it's generally a one-off, you know, go buy a property or a two-flat or a four-flat in Chicago from somebody. And if you want to get rid of it, you're generally going to have to go through a broker. You have to list it. By the time you get cash in your hands, it's going to take a very long time. Well, real estate, big real estate, is actually owned in a publicly traded market. So all the local huge shopping malls where you live, uh, here in Metro Chicago, we have the Oak Brook Mall, the Woodfield Mall, and all those big buildings that you see downtown Chicago, that's real estate as well. The big condo towers downtown, uh, and any suburbs, those are generally owned by some publicly traded real estate. So you can actually buy it like a stock. They own real estate properties, they collect rents, they pass the rents off to you, the owner of the shares, in the form of dividends. But it's truly passive. You have exposure to real estate, it's passive. A lot of these, um, corporate realty funds, they typically raise the dividend every year, and you can kind of lock that in. But it's truly passive, and you don't have to do any work. If there's any appreciation on the properties, it They're going to pass that along to you as a shareholder in the form of a higher net asset value. So your stock price should go up as well as the real estate value going up, and I should get a steady stream of income every quarter. More importantly, I don't have to do any work. And if I decide I want to change my mind and I no longer want to own real estate, I just hit a button and within about 3 to 5 seconds I'm out. Okay.

And then we've got two other categories. The— these are in the stock or equity markets. The first one, Nolan, The income model that we have here at Left Brain, there's 21 stocks in it. These are bond-like stocks. They pay an income each year. Explain what that is.

That's right. So we have a portfolio we've been keeping here. We have a lot of clients that are at that preserving wealth stage or they retire and now they need their portfolio to replace the paycheck that they were earning when they were working 9 to 5. So we've cataloged a group of what we call income securities. These are securities that trade publicly. So they trade every day that the stock market's open. But unlike stocks, you tend not to see a huge amount of up and down, primarily because when you buy stocks, they're based off of future cash flows. Stocks tend to not pay a lot today, but the promise is they're going to pay a lot in the future. With these income investments, they tend to pay most of their returns out today in terms of— in forms of high dividend yields today. And because of that, they trade based off of their cash flows. And because the cash flows are high and they don't change very often, it creates a lot more stability in the price of the shares.

Excellent. Nolan, in the final category is the good old S&P 500. Over history, that's, that's generated about 8 to 10%. Explain where that might fit into a portfolio.

Yeah. So for the investor that's looking to invest for appreciation, so, you know, I heard my grandmother bought this house for $100,000. 30 years ago, and now it's worth $1 million. I want to do the same thing. So if you're investing, you don't care about the cash flows today, you just want appreciation. And we'd like you to think about other alternatives. A good thing that you could do, or one option, is to just put money in stocks. And for our example, we're going to use the S&P 500. And if you just buy stocks, it's truly passive. You don't have to watch them. You can put them in the drawer and pull them back out 10 years later. And historically, over time, if you do that with stocks, they return about 10% a year, which means your $100,000 turns into $200,000 in about every 7 years or so. So that's another way that investors can get appreciation other than real estate is buying stocks. They're truly passive.

All right. Thank you for that, Nolan. These are some passive opportunities that are alternatives to real estate investing. We're going to put up again, we're going to put up a chart that shows you what each of these would generate over a 10-year period compared to the cash flow yield of our hypothetical real estate piece of real estate. Hopefully you'll get a sense of how the returns may be better in the passive world, but also be your life, maybe your quality of life may be much higher in the passive world as well. Well, we're going to close it out here. Any final thoughts for those who are looking at potentially investing in real estate or in passive securities?

Stress-free vacations and stress-free weekends. That's what I would like the, uh, enterprising budding real estate investor to think about, is quality of life. How much mental real estate, quote unquote, pardon the pun, that you're giving up if you decide to go down this road. I just want you to understand it's not truly passive, it's not liquid, um, and be careful when you take a look at the returns, of the returns you're targeting to make sure they are attractive enough for your capital and for your mental stress that you're going to be putting up with in order to have this piece in your portfolio.

Excellent. Thank you, Nolan. Thank you for all those words of wisdom. I want to thank all the viewers for being with us on Fundamentals of Investing, and we'll see you again next time.