Which one works best for you?

Most people own some real estate, and for the most part, those who don’t own property still list their desire to own in their financial forecast. Whether it is your primary residence, a second home or an investment property, there are several ways to look at real estate from an investment point of view.

For your home, it would be best to exclude this asset from your inventory of investable assets. In the financial planning world, we call your home a use asset. A use asset is something that theoretically will always remain something that you need to live, not something where you will be pulling equity to support lifestyle or to buy something. An exception to seeing your home as an investment may be if you plan to downsize (and move down in your price bracket) to pocket the sales proceeds above and beyond your cost for a new home.

For a second home, have a clear plan about use. Will you rent it out, ever? If not, then consider it to also be a use asset. If you will rent, then analyze it as you would any other real estate investment.

In general, the basic ways that investors may invest in real estate are for speculation, for the long term hoping for a gain or for cash flow.

Real estate as a speculative investment is very risky. In the past few years, I’ve seen many an investor buy something “on spec” and have it turn around in fairly short order with a gain. But I’ve also seen those bought “on spec” that sit on the market for months or years where the owners merely hope to get back as much as their original investment and renovation costs. This gets dangerous if that property is leveraged, as loans will increase your carrying costs materially.

Buying real estate for a long term hold could be a part of a long term strategy. It may lower your overall investment risk, especially if there is rental income or some other sort of cash flow generated.

Over the past century, it does appear that real estate has appreciated slowly but generally upward. But if you’ve owned property in the past 30 years, you know that outlook for real estate is merely a bunch of cycles that go both up and down. Your timing, on both the buying and selling side, can dramatically affect your overall rate of appreciation.

Investing in real estate for cash flow is another popular method. Whether you are writing a check or using some leverage, the objective here is to earn cash flow similar to a typical fixed income investment with a possibility of some appreciation over the long term. This also has some risk. Tenants don’t last forever, and some are better than others.

Regardless of the purpose for owning investment property, be sure to own it in a protected entity such as an LLC. Done properly, it can prevent a catastrophe from taking down your entire net worth.