Personal Finance for Professionals Part III – Real Estate Investing
Welcome to Part III of Personal Finance for Medical Professionals – Real Estate Investing. If you’ve made it through Parts I & II, you’ve already learned the foundation of personal finance and investing. We’ve talked about saving, investing, stocks, bonds, retirement accounts, and how to build a financial plan. Now we’ll discuss another asset class you may have heard a lot about: real estate.
My (short) Story
Before we get into the numbers, strategies, and different ways to invest in real estate, I want to share a bit of background to establish my credibility in this area. I spent about three years in real estate. My experience was primarily in wholesaling, which means buying a property for less than market value and quickly selling it to an investor for a profit. I bought and sold approximately 350 houses during this time, and I also acquired a few properties using creative financing to use as rentals. Oh, and my husband is a real estate agent.
Together, we did three flips. Flipping didn’t make us rich, but we didn’t lose money on any of them, which, in my opinion, is a win. There are as many ways to lose money in real estate as there are to make it. Eventually, I transitioned my focus to owning and operating my laundromat business and have since let go of the rentals we were holding.
So, I’m not coming into this section as someone who owns dozens of rental properties or has built a massive real estate portfolio. My experience is different. I’ve been on the transaction side of real estate. I’ve bought properties, sold properties, worked through creative financing, and renovated properties. I’ve seen deals that looked great on paper and deals that required a lot more work than they initially appeared. That experience has shaped how I think about real estate.
I don’t think everyone should invest in real estate. I also don’t think real estate is a magical path to wealth that you can follow simply by buying a few houses. But I do think medical professionals should understand how real estate works.
Your Personal Home is Not an Investment
The first thing you must understand is that owning a home is not the same as real estate investing. In fact, in most cases, buying a personal residence is the antithesis of investing. Too many medical professionals overspend on their personal home, leaving themselves “house poor” and with too little disposable income to actually invest. They try to convince themselves that building “equity” in their home is the same thing. It’s not.
For lower-income American homeowners, home equity accounts for 99% of their net worth. For higher-income homeowners, like medical professionals, the number is 42%.
We invest in stocks and bonds so that in retirement, we can sell them and live off the proceeds. Unlike those investment assets, your personal home is a use asset. You will still need a place to live in retirement, so unless you plan to rent or downsize, you can’t live off the sale of your personal home. In this series of lessons, we will discuss various types of investment real estate, such as rental homes, multifamily properties, REITs, and syndications. Please note that your personal home is not on this list.
Financial Vitals
I hope you’ve already read Personal Finance for Medical Professionals, Part I. If so, you’ve already been introduced to the Financial Vitals Checklist. If not, take a moment to review it now.
Real estate can be a great way to build wealth. It can provide cash flow, appreciate over time, offer tax advantages, and let you use leverage. But it also comes with its own set of risks. It’s not particularly liquid; it can be expensive, it can take a lot of time and work, and leverage can work against you just as quickly as it can work in your favor. So before you start asking, “What real estate should I buy?”, I think it’s more important to ask, “Am I ready for real estate?”
That’s where the Financial Vitals Checklist comes in. For almost all medical professionals, real estate investing falls under Step 7: Get Wealthy.
Before you invest in real estate, you should have the basics in place: protecting yourself with insurance, having an emergency fund, taking advantage of an employer match, paying off high-interest debt, funding an HSA if you’re eligible, and maximizing your retirement accounts.
Once your financial foundation is in place, real estate is one of many tools you can consider adding to your wealth-building strategy. And that’s really what I want this section to do. I’m not here to convince you to become a landlord, buy an apartment complex, or invest in a syndication. I want you to understand how real estate works so you can decide if it makes sense for you.
Let’s start with the most basic question: Why would you invest in real estate in the first place?
Why Invest In Real Estate?
One of the things that makes real estate interesting is that you can make money in multiple ways from the same investment. You can generate cash flow, benefit from appreciation, take advantage of certain tax benefits, and use leverage to increase the amount of real estate you can control. You don’t have to listen very hard to hear people talk about real estate as a way to build wealth. You’ll hear about rental properties generating passive income, tenants paying down the mortgage, and properties increasing in value over time. While all these statements can be true in theory, the reality is a little more complex. These potential benefits also come with risks and tradeoffs. I’ve briefly mentioned some of these already, so let’s take a closer look at the advantages and disadvantages of investing in real estate.
Diversification
As a medical professional, you have a significant, steady income from your job, and much of your net worth will likely end up invested in stocks and bonds inside your retirement account. Real estate provides another asset class that is fundamentally different than the stock market. Even within real estate, you can diversify. You can own a single-family rental in your hometown, a multifamily property out of state, commercial real estate, or invest in syndications or REITs that can have a national footprint. Don’t worry, we’ll get to the details.
Keep in mind that I’m not saying that real estate automatically provides better diversification. It just gives you another place to put your money.
Cash Flow
If you own a rental property, your tenant pays you rent, from which you will subtract expenses like your mortgage, taxes, insurance, repairs, maintenance, vacancy, management fees, etc. What’s left over is cash flow. This is one of the things that initially attracted me to real estate. I had the idea of replacing my medical income with rental cash flow. It is tangible. It felt safe. That is, until I realized how much it would cost to own that many rental properties. Just be careful when you talk about cash flow. Just because you are collecting $2,000 in rent doesn’t mean you are making $2,000 in cash flow (remember all the expenses we subtracted above). We’ll cover real estate math in more detail later.
Appreciation
Generally, real estate prices go up over time. Do you have a parent or grandparent who bought their house for $50,000 thirty years ago, and now that house is worth $250,000? That is appreciation.
If you buy a property in an appreciating housing market, you can sell it later for more than you paid. You made money because the property increased in value. Historically, single-family real estate has appreciated at about 3% per year. Some markets more, some less. Some years more, some years less. Some markets even lose money over time. Each market and property has its strengths and weaknesses and will appreciate or depreciate at its own rate.
Some markets and property types are best for cash flow, while others may barely break even, but appreciate well over time. Before you invest in real estate, you must understand a market’s strengths and weaknesses.
Tax Advantages
Another reason real estate gets so much attention from investors is the tax treatment. This can be confusing at first, but one term you will become familiar with is depreciation. Basically, the IRS lets you expense a part of your property’s value each year. This effectively reduces the portion of your rental income subject to tax.
Real estate also comes with other deductions related to owning and operating an investment property. You can deduct mortgage interest, repairs, management fees, and other property-related expenses to reduce your taxable income.
A 1031 exchange is another tax advantage of real estate investing. This allows an investor to defer capital gains when selling one real estate property and buying another one.
These tax advantages are particularly interesting for high-income earners, like medical professionals. You have a significant amount of taxable income from your job, so having an investment that can generate additional income and have favorable tax advantages can be attractive. We’ll get much deeper into how depreciation, deductions, and other real estate tax strategies work in a future lesson.
Leverage
Leverage is simultaneously the most powerful aspect of real estate investing and the quickest way to get yourself into trouble. With real estate, you don’t have to have the cash for the entire price of a property. A mortgage loan allows you to control an asset for a fraction of its purchase price. For example, if you put $40,000 down on a $200,000 property, you now control a $200,000 asset with only $40,000 of your own money. That means if that property increases in value by 10% ($20,000), you make a 50% return on your original investment. That sounds nice, right? It can be. But leverage works the other way, too. If the property’s value drops 10% ($20,000), you lose 50% of your investment. We will spend more time on leverage later, because it is imperative that you get it right.
Disadvantages
This is the part I think most people leave out. Real estate investing has some significant downsides. First, unlike the stock market, real estate is illiquid. You can’t decide on Tuesday that you want your money back, sell your house, and have the money in your account by Wednesday. Selling a property takes time and money. Second, real estate has high transaction costs. Buying and selling real estate isn’t free. Closing costs, commissions, financing costs, repairs, maintenance, and other expenses come with owning and selling real estate. Third, real estate isn’t always passive, like the gurus want you to believe. Sure, you can hire a property manager, which eats some of your profit, but at the end of the day you own the property and need to make decisions. Things break, tenants leave, and problems will come up.
Finally, leverage can be risky. What can make your returns look great when things go well can also turn a bad investment into a bad situation where you lose money. You can also easily become overleveraged. This is especially important for medical professionals. Just because a bank will lend you a large amount of money doesn’t mean you should borrow that much. So yes, there are advantages and disadvantages, and you should understand both before you jump in.
Real Estate Is Not a Requirement
If you have read Personal Finance for Medical Professionals Parts I & II, you should know that you can regularly and automatically invest in index stock and bond funds, focus on your career, and wake up rich in 30 years. Real estate is not a requirement.
There is a lot of pressure to do what everyone else is doing. Some doctors you work with may own rental properties, or you might be offered the opportunity to participate in a syndication one day. If you are on social media at all, you will start to feel like you’re missing something if you don’t buy real estate. You’re not.
Once you understand the risks and benefits of real estate investing, if you decide it fits in your financial plan, great. Real estate investing can be a career, passion, side hustle, hobby, or a diversification strategy. However, if you decide real estate isn’t for you, that’s reasonable too.
What’s Next?
In the next few lessons, we’ll discuss the different ways you can invest in real estate, how financing and leverage affect your returns, and the basics of real estate math. We’ll also take you through some real-life examples of our successful and not-so-successful real estate deals.
Is real estate investing right for you? I don’t know. The goal of this series is to give you enough information to make an educated decision for yourself.