Millennials and Real Estate Investing: 4 Pros and 4 Cons To Consider
Real estate investing has captivated the Millennial Generation, luring them with promises of prosperity and financial freedom. The Internet and social media—favored sources of information for millennials—are filled with abundant resources and advice highlighting the benefits of real estate investing while often conveniently glossing over essential considerations and concerns that aspiring investors should be thinking about.
However, when approached with a dose of reality, we all know that investing in real estate is no small endeavor, particularly if you opt for direct ownership (more on that later). It demands a balanced perspective and careful consideration of potential benefits and drawbacks before commitment.
No matter how alluring of an opportunity, it’s important to acknowledge that real estate investing may not be suitable for every investor or phase of life. However, by understanding the potential downsides, you’ll be better equipped to navigate any challenges that come your way once you’re ready to add real estate to your investment portfolio.
Now that we’ve set the intention of providing a well-rounded perspective free from pressure to rush into the real estate market based on interest rates or market timing, let’s uncover some pros and cons of real estate investing for millennials:
Potential Benefits
Potential for appreciation and rental income
Portfolio diversification
Leverage
Ownership options
Potential Drawbacks
High initial and ongoing costs
Risks and uncertainties
Illiquid asset
Limited control and returns with indirect ownership
Investing in real estate is undoubtedly exciting, but don’t minimize the importance of having the knowledge and insights to make well-informed decisions and navigate this venture confidently.
The Pros of Investing in Real Estate
Let’s take a closer look at some of the potential benefits that have millennials eager to venture into real estate investing.
1. Potential for Appreciation and Rental Income
It only makes sense to kick things off with the most glaring and compelling reasons why many millennials are attracted to real estate investing in the first place—the opportunity to enhance their net worth and generate additional income streams.
Real estate has a proven track record of long-term appreciation, positioning it as a reliable investment option for consistent and sustained growth. In an optimal scenario, the value of your property follows historical trends as you build equity in it over time.
This opens up the possibility of a financial windfall if you decide to sell the property down the line, or it can be harnessed to fulfill another increasingly popular financial goal among millennials—building generational wealth.
Then there’s the immediate benefit you don’t need to wait years to experience—rental income. This additional source of income can help you gradually pay down your mortgage or related expenses without emptying your own pockets.
Alternatively, it can serve as a supplementary source of funds to cover other expenses or financially support other goals or passions.
2. Portfolio Diversification
If you have any interest in personal finance, you’re likely familiar with the concept of diversification and the wisdom behind not putting all your eggs in one basket. As a distinct asset class, real estate can add a touch of diversification beyond traditional investments to an investment portfolio.
Real estate often exhibits a low correctional with traditional investments like stocks and bonds, meaning its performance may not move in the same direction or magnitude as those assets. While the real estate and stock markets are closely intertwined, the real estate market can be influenced by other factors, such as location and population growth, which extend beyond the movements of the broader stock market.
This means that during periods of stock market volatility and decline, real estate investments may show more resilience, potentially serving as a buffer within your portfolio.
Additionally, as mentioned, real estate investing presents diverse income opportunities, including value appreciation and rental income. This unique combination of income opportunities and low correlation with other assets has the potential to mitigate portfolio risk and boost returns.
3. Leverage
Have you ever wondered how investors build up their impressive real estate portfolios? Here’s a little secret: leverage. While a fortunate few may have the means to cover down payments and upfront expenses for multiple properties with their own funds, most investors use the powerful tool of leverage. This strategy allows you to use borrowed funds, typically in the form of a mortgage, to purchase additional properties.
To give you a good idea of how this strategy works, let’s walk through the process step-by-step: You purchase your first investment property. As the value of that property increases, you start building equity, which is the difference between its market value and the remaining mortgage balance.
Now, here’s where leverage comes into play. You can tap into the equity you’ve built in your first property by either refinancing or taking out a home equity loan. This gives you access to cash based on the increased value of the property, which you can use as a down payment for a second property.
This is a repeatable strategy that has the potential to amplify your returns and allows you to acquire additional properties without the need for substantial upfront capital.
4. Ownership Options
Gone are the days when direct ownership was the only path to real estate investing. As the demand to own real estate has surged in recent years, so too have the options and accessibility for investors.
Suppose you’re interested in investing in real estate but lack the necessary capital or prefer a more hands-off approach to ownership. In that case, you can explore alternative options like indirect ownership through avenues such as Real Estate Investment Trusts (REITs) or real estate crowdfunding platforms.
Moving beyond these conventional methods, there are some innovative approaches to real estate investing. One notable option is investing in real estate with a self-directed IRA (SD-IRA).
Unlike Traditional and Roth IRAs that limit you to stocks, bonds, and mutual funds, an SD-IRA allows you to invest your retirement funds in a broader range of assets, including real estate. What’s the motivation behind this approach, you might be wondering? Let’s briefly highlight a few benefits:
Tax-Deferred or Tax-Free Growth: A key similarity between SD-IRAs and regular IRAs is the tax advantage they provide. For instance, contributions to a Traditional SD-IRA are tax deductible, and your real estate investments can grow tax-deferred. This means you won’t pay taxes on income or capital gains until you withdraw during retirement.
On the other hand, contributions to a Roth SD-IRA are made with after-tax dollars, meaning you won’t receive an immediate tax deduction. However, the advantage is that any qualified withdrawals, including income or capital gains, are tax-free.
Protection: Since an SD-IRA is a qualified retirement account, assets within it generally receive some level of protection from personal liability. That means, in most cases, these assets can’t be accessed or seized in the event of a personal lawsuit or even bankruptcy.
Exciting opportunities have emerged in the ever-evolving world of real estate investing, breaking down the barriers of accessibility and providing investors from all walks the chance to partake.
The Cons of Investing in Real Estate
Now, shifting our focus to the less glamorous but equally important part, let’s uncover some potential drawbacks of real estate investing.
1. High Initial and Ongoing Costs
Many millennials are in a pivotal stage of life, juggling a multitude of financial responsibilities and goals. They are on a mission to create a life of their own design—from traveling the world to retiring early and everything in between—while also grappling with the reality of student loan debt, saving for their children, and a myriad of other financial obligations.
When you’re already stretched thin financially, it can be challenging to pursue additional goals that demand a significant amount of capital. This is especially true for younger millennials who may have limited access to funds due to their relatively shorter time in the accumulation phase of life.
Even when capitalizing on certain advantages like negotiating reduced closing costs or securing a special loan with a lower interest rate, there is still an initial financial commitment that can be overwhelming for many millennials.
Moreover, it’s crucial to factor in the ongoing expenses associated with real estate investing, including mortgage payments, property taxes, and insurance. While it would be ideal for these expenses to be covered by a tenant, there may be occasions when you need to be fully prepared to handle them on your own.
2. Risks and Uncertainties
There is a wide spectrum of risks and uncertainties involved in real estate investing, ranging from the unpredictable twists of an economic downturn to troublesome tenants or even the absence of tenants altogether.
An economic downturn, for instance, has the potential to disrupt lives, uprooting people and pushing them to seek more affordable housing options. This may, in turn, require you to adjust rental rates or manage through periods of vacancy, both of which can impact your bottom line and leave you vulnerable to unexpected expenses if you’re not adequately prepared.
Alternatively, you may encounter tenant-related issues ranging from late or non-payment of rent to property damage or difficulty retaining long-term tenants. While having robust insurance coverage and a reliable property manager in place can help alleviate some of these challenges, some situations may demand your direct involvement, immediate attention, and financial preparedness.
3. Illiquid Asset
While the prospect of seeing your net worth climb can be exhilarating, this growth doesn’t automatically translate into increased cash flow or a more extensive financial buffer as a means to overcome some of the risks and uncertainties we’ve discussed.
A high net worth on paper doesn’t guarantee immediate access to the corresponding cash, especially when a substantial portion of that net worth is invested in real estate assets.
Real estate is known for its relatively low liquidity, making it less than ideal for addressing immediate cash needs. Converting real estate assets into cash can be a time-consuming process that involves listing, marketing, and selling the property.
It’s important to recognize that investing in real estate is not a quick fix for improving financial flexibility and resilience. Instead, it’s typically a long-term endeavor that requires patience unless you are in the buy-flip-sell game for quick returns.
4. Limited Control and Returns with Indirect Ownership
The reality is that many millennials aren’t yet in a position to pursue direct ownership of an investment property, which may restrict them to the alternative options of indirect ownership. While these options can provide a glimpse into ownership, they fall short of the full experience of owning an actual home or other property.
You won’t have the creative freedom to personalize and arrange the home according to your preferences, determine its usage, or even choose the ideal time to sell.
This is similar to investing in stocks, where you become a fractional owner of a company but lack significant influence or authority. While you may have occasional voting rights, you wouldn’t typically refer to yourself as an owner of entities like Amazon or Apple based on stock ownership.
Just like the limited control you experience with indirect ownership, the benefits and returns may also have their limitations. For example, a $10,000 investment probably won’t yield a monthly return of $1,000 or provide a six-figure lump sum of cash when the property is sold.
It’s essential to set realistic expectations and understand the constraints of this type of investment.
How Chicago Trust Administration Services Can Help
Real estate investing presents an exciting wealth-building opportunity, but it’s important to acknowledge both the benefits and drawbacks involved rather than being solely captivated by its allure. Evaluation of the pros and cons isn’t intended to dissuade you from becoming a real estate investor but rather to position and empower you as a prudent investor.
As you embark on your journey as a real estate investor, it’s natural to encounter unfamiliar terrain. Seeking guidance in navigating this path is perfectly acceptable and even highly advisable if taking a less traditional approach to getting started.
At Chicago Trust Administration Services, we’ve helped many clients integrate real estate into their investment portfolios using a self-directed IRA. To determine if this is a viable and beneficial option for your specific situation, we invite you to schedule a complimentary meeting with us by calling 312-869-9394 or emailing steve@ctasira.com.
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*The content and opinions in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
**CTAS professionals are not financial advisors and cannot provide advice or recommendations regarding specific investment decisions.