Despite real estate ranking second to last in my Passive Income Rankings, don't worry real estate fans. Real estate still is my favorite asset class to build wealth. This article will discuss whether to invest in real estate for capital appreciation, rental income, or lifestyle.
For me, I invest in real estate for lifestyle first. I want to live in and enjoy my home. It feels GREAT to enjoy my investment and have it potentially go up as well.
I then want to invest in real estate for rental income. This is why I've been buying rental properties over the past 20 years. Real estate now accounts for about $150,000 of my investment income.
Finally, I invest in real estate for capital appreciation. My belief is that if you can enjoy your real estate and grow its rental income, capital appreciation will naturally come. And what a win to be able to enjoy your money while it grows!
Capital appreciation is really just a feel good factor that helps boost your net worth. Given the ideal holding period for real estate is forever, capital appreciation is really only for short-term investors.
Invest In Real Estate For Capital Appreciation, Rental Income, Or Lifestyle?
One of the reasons why I love real estate is because of the utility it provides. I don't buy real estate mainly for rental income or capital appreciation. I buy real estate for improving my lifestyle first.
If the property so happens to appreciate in value while I enjoy the place over the years, fantastic. If not, it doesn't matter because I've derived tremendous satisfaction from all the property brings: location, view, amenities, and memories. Capital appreciation is just a bonus.
Money earned is best spent on improving your lifestyle. It may be fiscally prudent to hoard as much cash as possible for a rainy day. You might grow your wealth faster by buying multiple rental properties while you rent a piece of crap place to save money. This is my BURL real estate investing rule in action.
However, at some point, there has to be a better balance when it comes to spending money. If you can spend money on an asset class that provides a better lifestyle and a chance for capital appreciation and rental income, you're hitting triples and home runs!
Desirable Real Estate Features
There are several real estate features I, along with plenty of buyers covet:
1) An open gourmet kitchen with a large peninsula or island
2) A walk-in closet
3) A luxury master bathroom with deep soaking tub, separate rain shower, and enclosed toilet stall
4) Peace and quiet
5) A room or two with a view
6) A deck
7) An outdoor hot tub
As someone who spends a lot more time at home now after retiring from Corporate America, my appreciation for nice amenities has gone up. I've got to imagine it's the same thing for many stay-at-home spouses. This post is a discussion about point #5, recognizing value, and figuring out what the future holds in real estate.
Investing In Ocean-view Properties
When I was in my 20s, I'd always face the dilemma of paying up for a room with a view or getting an inner courtyard room with no view for half price while on vacation. It always felt silly paying $400 a night for a view when I could just walk outside the hotel and have the same view for free. So, I never did.
I began obsessing about ocean views once I moved to San Francisco in 2001. In 2003, I was able to buy a condo with a view of the park. It was a lovely view that transported me away from the busy city, and into a jungle every time I sat down on my living room sofa.
I loved the tranquility of a park view. It was as if I had a huge backyard that needed no maintenance. In fact, nine years later, the city spent $10 million dollars renovating the park with an amazing playground, huge walking paths, a dog park, and two pristine tennis courts.
From Condo To Single-Family Home
Two years after purchasing the park-side condo, I longed for something else: a single family home. Condo living is fine, but I wanted to have more freedom with my living space.
So, I bought a house that I lived in for almost 10 years, but it had no view. My obsession with having a room with a view kicked in five years after moving in. I found myself climbing up to the roof once a month, wondering whether it would be worth the money and the hassle to expand one floor up in order to catch a glimpse of the Golden Gate Bridge in the distance.
Knowing how difficult it is to build upward in San Francisco, I decided to do nothing. Instead, I biked down to the water's edge and watched the sailboats float by Alcatraz during sunset as consolation.
Time To Look Once More
After 10 years in the viewless single family home, I was itching to explore a different neighborhood or relocate to a different city altogether. I had a mobile business after all, so why not go on a new adventure?
There was no need to commute downtown five days a week anymore, which is a relief since downtown San Francisco feels like congested Manhattan nowadays with 100,000 more people employed than five years ago, and 55,000 more people employed than the height of the dotcom bubble according to the California Employment Development Department.
Going back to Honolulu was also at the top of my list for its incredible weather, beautiful beaches, emphasis on family, and kick back lifestyle. If only I could bring Hawaii to San Francisco, I kept thinking to myself. Buying property in San Francisco is less risky due to the plethora of high-paying jobs.
Then one Spring evening in 2014, I found my existing home by accident. It was a fixer that was poorly marketed on the Multiple Listing Service by an out-of-town agent. He didn't have a single picture online, despite marketing the house as having “panoramic ocean views.” Talk about bad marketing. I had to check it out for myself.
Found A Diamond In The Rough! A Fixer!
When I stepped inside there was gross green carpet everywhere (picture above). The paint was falling off and the bathrooms and kitchen hadn't been updated in over 60 years. It was a true fixer-upper.
But all the interior ugliness disappeared once I saw the view. The view was to die for and I was willing to pay 50% more than the $1,250,000 asking price just for the view alone.
But instead of paying $1,074 a square foot for my house, I paid $716 a square foot. I knew I would have to put around $100,000 into rehabilitating the home with a new roof, new outside and inside paint job, new floors, new kitchen, new bathroom, new 200 amp electric panel, and new electrical wiring. But that would still be $525,000 less than the $1,875,000 I would have paid.
Despite people telling me how much cheaper these homes in Golden Gate Heights were five years ago, I didn't care. The properties I own rode up with the market as well, and it was just unbelievable to think that I could finally find not one room with a view, but five rooms with a view of the ocean.
Value Is Subjective In Real Estate
There are plenty of people who couldn't care less about a view. They would rather have a larger size room or bigger home instead. That's fine because if everybody wanted a view, I wouldn't have been able to afford my house.
The key is to be a little contrarian with your desires. A room with a ocean view is a pretty common desire. But buying property in Golden Gate Heights hadn't really caught on yet because it is five miles west of downtown San Francisco.
I surveyed over 100 people during my property hunt and less than 10% knew where Golden Gate Heights was. One 28 year old woman jut the other day said she lived one neighborhood over all her life and had never heard of GGH. Perfect. Everybody is focused on Pacific Heights, Noe Valley, Hayes Valley, Russian Hill, and The Marina where property prices have gone ballistic already. It's costly to go with the crowd.
Invest In Growing Economic Areas
Instead, look ahead and see whether there's a possibility others might see in the future what you see today.
Research public transportation expansion plans and buy property close to those respective stations. Research whether new restaurants, stores, or buildings will be built that will attract more demand. For example, the west side of San Francisco should continue to boom with new schools and job growth.
Those who are willing to spend lots of money expanding have surely done their due diligence as well. Local economic catalysts are key for sustained price appreciation in the neighborhood you want to buy. Take advantage!
If you can successfully look ahead, you'll be able to save a lot of money now or develop a lot more wealth in the future. And even if the future price never materializes, remember the point about buying property for a better lifestyle first.
The Real Estate Market Is Efficient
Here's what I wrote in my post on the best place to buy property in any major city published on June 6, 2014:
” The majority of prime real estate in San Francisco is closer to $1,100-$1,500 per square foot if we exclude the $3.4 million “outlier” mentioned above at $2,200/sqft. But even at $1,500/sqft, that’s still cheaper than the $2,000 – $3,000 per square foot in places like Hong Kong, London, and Manhattan. San Francisco is turning into a major international city before our eyes with all the cranes downtown due to the profitability of tech firms e.g. Facebook is set to pull in over $10 billion in revenue and $2.5 billion in net profits in 2014. Revenue and earnings are estimated to grow in the double digits for years.
I see the average Golden Gate Heights view home reaching well over $1,000/sqft by 2019 if not sooner as long as the economy remains stable. Let’s just hope local residences discover Golden Gate Heights before foreign buyers do. From what I know and hear, Chinese and Russian buyers are buying prime properties around the nation in droves, sight unseen.”
My prediction was that GGH homes selling for only $700 – $800 / sqft in 2014 would rise by 30 – 40% over the next five years. After only eight months, I'm surprised to say my prediction has come true. Almost every weekend I go for a one hour hike around my neighborhood to exercise, visit open houses to get a pulse on the market, talk to realtors, and find inspiration for design.
Real Estate Outperformance Examples
See the listing below. It's closer to a fixer, than a remodeled home.
A two bedroom, one bathroom, 1,174 square foot home on a healthy 4,599 sized lot (half of it is majorly downward sloping) just sold for $1,350,000 from a $975,000 asking price. That's $1,149.91 per square foot!
I went to check out the house after it sold and it does have an equally amazing panoramic view of the Pacific Ocean and the Farallon Islands. There's a possibility for expansion potential as well if the new owners build out about 15 feet to get that extra bedroom and bathroom.
What Will The Future Of Real Estate Hold?
Besides the example of 2001 14th Avenue selling for over $1,000 / sqft, I'm seeing other examples of GGH properties now selling for over $1,000 / sqft (199 Quintara and 2219 12th Ave).
It is crazy how efficient the market is, and now I'm wondering what's next? If you go to any big city in the world, ocean views trade at huge premiums, except for in San Francisco for some odd reason. If you can find ocean view homes for less than $1,000 / sqft, buy all you can.
Buying real estate for capital appreciation is like buying a growth stock. But none of it really matters if you never sell. I don't plan to ever sell my current primary home, despite a 50% increase in comparable prices because I enjoy my home.
I honestly don't care about a realistic $250,000 – $350,000 gain (20% vs. 50%) after remodeling because if I sell, where would I go if everything else has also moved up in price? Even if the property takes a big dive, like my Lake Tahoe vacation property did during the downturn, there's only a psychological impact.
For those of you who live in more reasonable priced markets, real estate is a much better investment for rental income instead of capital appreciation. If you can get net rental yields of greater than 8% (~4X the risk-free rate of return) after putting down 20%+, you're probably going to do pretty well.
Investing In Real Estate Today
The more I think about it, the more I believe most of us should just buy a home to enjoy. Chances are high that if you like your home enough to buy it, others will too. Save your money while enjoying your home, and when the time comes for you to make a change (family, empty nester, change of scenery), you can rent out your home and buy another.
If you can start this real estate empire building process by age 30, by the time you're 60, you'll be able to comfortably amass three to four properties with probably a decent amount of capital appreciation, rental income, and fantastic memories to boot!
Easiest Way To Invest In Real Estate
If you don't have the downpayment to buy a property, don't want to deal with the hassle of managing real estate, or don't want to tie up your liquidity in physical real estate, take a look at Fundrise. Fundrise is one of the largest private real estate companies today. You can use Fundrise to surgically invest in real estate without leverage.
Another great private real estate investing platform is Crowdstreet. Crowdstreet offers accredited investors individual deals run by sponsors that have been pre-vetted for strong track records. Many of their deals are in 18-hour cities where there is potentially greater upside.
If you want to get more surgical in your private real estate investments, Crowdstreet is a strong solution. I've met the people at Crowdstreet on two separate occasions and came away impressed with their risk-management and product offerings.
I've personally invested $953,000 in real estate to diversify away from my expensive SF real estate holdings. I also want to earn more income passively and not have to deal with maintenance issues or tenants.
Don't Forget To Shop Around For A Mortgage
Check the latest mortgage rates online through Credible. They’ve got one of the largest networks of lenders that compete for your business. Your goal should be to get as many written offers as possible and then use the offers as leverage to get the lowest interest rate possible.
Buy A Home And Invest In Real Estate For Lifestyle, Income, Or Capital Appreciation is a Financial Samurai original post. Join 60,000 others and subscribe to the free FS newsletter.