Real estate investing can be very profitable. But it does have some significant disadvantages.
- Business risk. It is quite possible to lose money in real estate investments. A local recession can depress prices. Zoning changes can slash housing values. Some property values simply decline, and so do rents. Rents will not keep up with costs in communities in which industries and jobs are moving elsewhere or in deteriorating neighborhoods.
- Complexity. Real estate investments require much more investigation than do most other investments. Numerous assumptions about financial details in the future also must be made.
- Large initial investment. Direct investment in real estate generally requires many thousands of dollars, often with an initial outlay of $15,000, $30,000, or $50,000.
- Lack of diversification. So much capital is required in real estate investing that spreading risk is almost impossible.
- Dealing with tenants. Someone has to screen rental applicants for their credit histories, criminal records, work references, and experience with previous landlords. State laws may make it impossible to evict a deadbeat tenant for several months. Picking the wrong tenants can quickly turn a real estate property into a financial loss.
- Time-consuming management demands. Managing a real estate investment requires time for conducting regular inspections of the property, dealing with insurance companies, making repairs, and collecting overdue rents.
- Low current income. Expenses may reduce the cash-flow return to less than 2 percent or even generate a net loss in a given year.
- Unpredictable costs. Estimating costs is problematic. Investors cannot control increasing real estate tax assessments or when a central air-conditioning unit might break down. Interest rate risk. , when interest rates rise, fewer people can afford to buy homes, and this puts downward pressure on prices and rents.
- Legal fees. The services of a real estate attorney will be needed to help handle the real estate purchase, sale, building inspections, zoning issues, tenant problems, insurance disputes, and any liability issues.
- Illiquidity. Real estate is expensive, and the market for investment property is much smaller than the securities market. As a result, it is common to experience trouble in selling. It may take months or even a year or more to find a buyer,arrange the financing, and close the sale of a real estate investment.
- High transfer costs. Substantial transfer costs, often representing 6 to 7 percent of the property’s sale price, plus money for fix-up costs, may be incurred when real estate is bought or sold.
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