San Francisco Real Estate - Residential

The wisdom of real estate investing versus other investments

A reader asks:

I have been looking over the market reports posted on your website and see that from 2002 to 2006, the May statistics show that my single family home has risen in average value by about 57% which averages out to about 14% a year for that 4 year span. Why would I take such a chance on something so volatile as the real estate market (possible market changes, rising interest rates if I have a variable rate loan or other unknown factors), when there are much more stable investments like the stock market (which has returned about 10% a year (on average) or maybe even buying a triple net lease?

Our reply:

Thank you for your question. Obviously you given this a lot of thought. Experts agree on several things when considering investing.

• First, should you invest and why?
• Second, where are you going to invest?
• Third, do you understand the risk versus the expected return?
• Fourth, how much risk are you willing to take?
• Fifth, is your investment liquid and does it need to be?
• Sixth, are you diversified?
• There are other factors, but these are usually the main ones.

Let's take a look at your last example first, triple net leases. Investopedia defines these as, "A lease that designates the tenant as being solely responsible for all of the costs relating to the asset being leased. The costs could include any upgrades, utilities, repairs, etc." Horn Capital Realty of Bay Harbor, Florida says, "The triple-net lease offers a long-term lease with the guarantee of steady cash flow and practically no risk." As this points, out there is practically no risk, so the reward is usually set at a cash on cash return of about 10% which is better than some other investments. As part of a diversification plan to investing, these are great money makers. We have some of these ourselves.

Your second example, the stock market, though relatively stable over the long-term, it can also be very unstable in the short term. True, they address item 5 above; liquidity. With an online account, you can buy and sell almost immediately. There are lots of websites dedicated to setting up accounts to buy and trade stocks. There are also lots of informational websites. How to Advice by Charles M O'Melia is a pretty good place to start. As long as the stock market continues to go up, the cash on cash return remains about 10% on average (this would probably apply more to mutual funds, of course) and a savvy investor could make much more on individual stock picks. But you invest $100 you buy $100 worth of stock. As part of a diversification plan to investing, these are also great money makers. We have some of our investments in mutual funds as well.

Now let's talk about our favorite tool for building wealth, real estate. You pointed out that San Francisco real estate from May of 2002 until May of 2006, the return is roughly 14% a year for probably much riskier than the above 2 investment types. But let's take a simple example of a single family home selling for $1,000,000. Even for San Francisco, that's a little low, however, it's a nice, round number! So let's use that. Many people are buying homes with 10%, 5% and even 0% down, but let's use an example of 20% which is pretty common (especially now that interest rates are rising rapidly on the second loans which are often necessary with 90% financing - often called 80-10-10 financing. That's 80% first, 10% second and 10% down payment). Are you with us so far?

With this example, the 20% down payment would be $20,000. On an investment valued at $1,000,000 that rises in value at 14% a year, that property would then be worth $1,140,000. That's 14% on the investment, but a 700% cash on cash return. Of course, this represents the rosiest of scenarios.

But consider a more normal scenario. Let's say the market rises only 2% for that year. On a $1,000,000 property that's $20,000. In this case, the cash on cash return would be 100% return. Rich Dad author, Robert Kiyosaki and his Rich Dad advisors like Dolf DeRoos and Diane Kennedy all agree that Real Estate is one of the best ways to build wealth! Of course, when and where you decide to invest will ultimately make this a good or bad deal.

- Mick Orton

posted by SFResidence.com @ 7:16 AM