Here at Cook Wealth, our joint Wealth and Tax Advisor team gets a lot of questions about real estate investing. Especially in times like this, when stock market returns are less than favorable, clients wonder if real estate is a wise investment, how to start investing in real estate, and how to make a long-term plan that safeguards their financial future.
To answer these burning questions, and a few more, we sat down with Derek Williams, CFP® to discuss investing, taxes, financial planning, and more. Check out his insights below, then reach out to the team here if you still have questions!
4 Real estate investing questions we hear often
1. What do I need to know before I become a real estate investor?
Something that surprises a lot of new real estate investors is how complicated your taxes will become once you begin buying properties. Even if you start with just one investment property, your tax situation significantly changes.
As a couple or single person, before you buy your first rental property, you probably have very simple taxes. Most likely, you have a W-2, maybe some investment income, charitable giving, and that’s about it. You can probably file your taxes for less than $100 on TurboTax. But the minute you add real estate investments to the mix, you instantly triple or quadruple your tax-related paperwork and filing expenses. Suddenly, you have to think about:
- Extra income
- Depreciation
- Write-offs like home repairs and mortgage interest if you used financing
- Capital gains due after the sale of your property
And what used to cost you a hundred bucks and three hours of thought now costs thousands— and a CPA on speed dial.
I don’t share this story to scare you away from real estate investing, but to help you understand the complexities of this investment strategy. And to encourage you to work with a financial advisor (like the real estate investment advisors and tax professionals here at Cook Wealth!) before you make the decision to buy property.
2. Is real estate investing the right investment strategy for me?
There are lots of levels to real estate investing, so there’s not exactly a one-size-fits-all answer to that (or any financial planning question, for that matter!). Some of our clients have inherited property from a family member and now face the decision to sell it or convert it to a rental property. Others are looking to get into the short-term rental market and have a property or two they offer online. And a handful of our clients have a full portfolio of real estate holdings and treat this investment as their full-time job— even going so far as to develop land and add more units to it!
So, I wouldn’t be serving as a helpful real estate investment advisor without first asking what level of investing you’d like to get into. For casual real estate investors, 1-2 rental properties can be simple, manageable, and fairly lucrative— as long as you recognize that real estate investments do require more time, effort, and headspace than most assets in your investment portfolio.
From a financial planning perspective, I think it’s also important to mention that real estate can be a good investment, but it’s no replacement for traditional saving and retirement planning. In most cases, I advise clients to make sure they’re on track to max out their 401(k), build a strong nest egg, and leverage their guaranteed benefits first. Then, if they have additional money leftover to invest, they can choose to put it towards a real estate investment. That ensures they’re set up to meet their financial goals, even if this investment doesn’t pan out. It’s the same risk-hedging advice I would give for any large investment.
3. Will my real estate investment generate passive income?
This may be one of the most misunderstood aspects of real estate! In truth, there’s no such thing as a completely passive real estate investment if you want to fully own the property. Rental properties take considerable work, and AirBnBs require management, maintenance, and cleaning. Even flip houses require extensive (and often expensive) work and contractor management.
Here’s what inevitably happens: The pipes burst in your rental property at 2am, and instead of calling you, the tenants call an emergency plumber. He comes in the middle of the night, charges $1,000 an hour, and you’re stuck with a huge bill for a fix that would be a third of the cost during daytime hours. And you’re stuck footing a surprise bill and liaising between the plumbing company and your renter. Remember, every time your renter gets locked out of the unit, something breaks, or the property turns over, you have to devote time, energy, and money to your investment. And really, it becomes like a part-time job.
You do have the option of hiring a property manager, but many companies charge 10% or more for their services. That, plus maintenance costs and property taxes, can really eat into your profit margin.
In my experience, the most successful real estate investors— and our real estate investment advisor team works with many here at Cook Wealth!— are those who can manage their own properties, do light repairs, and live near the home. That’s the best way to maximize your ROI and minimize the headaches.
By the way, if you’re looking for truly passive assets, consider:
- Investments. There’s still a learning curve to stock investments, but when you have a financial advisor assisting with asset management, maximizing your tax savings, and helping you maintain your financial plan, you can be sitting on the beach enjoying your earnings— not dealing with tenants and repairs!
- Real Estate Investment Trusts (REITs). You can buy into them just like stocks. REITs allow you to invest in real estate and real estate companies without owning the property (and shouldering the liability) yourself.
- Real Estate Partnerships. You can help fund the real estate investment activity of a friend or connection, without taking on day-to-day responsibility for the property. Before entering a partnership arrangement like this, it’s always smart to consult your real estate investment advisor.
4. What services do the real estate investment advisors at Cook Wealth offer?
When we work with potential real estate investors, we start by talking through the pros and cons. We evaluate this investment from a financial planning perspective, asking questions like:
- How might real estate transactions impact your long-term financial life?
- Do you have the cash flow to support this project?
- Does it make sense to invest money into this right now?
- When it comes to money, will you secure financing, tap into your savings, sell some securities, or use another investment?
- Does this align with your investment goals and risk tolerance?
- Is residential or commercial real estate investing a better fit for your interests?
Once we’ve done our due diligence together, if the transaction still makes sense for our client’s investment portfolio, we’ll start crunching the numbers.
We start by running the Internal Rate of Return (IROR) for our clients to determine how much they’ll actually make from this investment. We’ll calculate their expenses, management fees, common repair costs, and the average income for the property to get that number. Sometimes, especially if our client is considering commercial real estate investing, we’ll look at other numbers, like the CAP rate, to compare two investment options.
On the tax side of things, our financial advisors will help you manage your expenses and minimize your tax burden, while helping you stay diversified in a healthy way.
Our goal as financial advisors is not to talk you into or out of a real estate investment. It’s simply to give you concrete numbers to base that decision on. That way you’re not deciding based on feeling, sentimentality, or what your friend or family member is doing, but based on what’s the smartest for your financial life and personal goals.
Looking for a Wealth Advisor, Real Estate Investment Advisor, or Tax Advisor? At Cook Wealth, our team offers all three!
When it comes to making one of the most costly investment decisions of your life, you can’t afford anything less than the best advice. That’s why the knowledgeable team here at Cook Wealth offers a variety of services to help you choose the right path forward. Jump on a quick, 15-minute call with our team to start the conversation.