This post is one in a series of posts featuring my wife, The Mrs. I asked her to pretend that she was a wealthy woman with $2,000,000 (million) to invest. This money was needed to provide her for the rest of her life. She is to ask questions that might come up in the course of investigating a new investment advisor. Please check back for more questions.
Question #2: Is there a chance I would lose my money by investing in real estate?
The short answer is yes. Real estate is an investment and there is a chance that money can be lost.
However, nothing is a guaranteed investment. There is some risk, though it may be incredibly small, no matter where you put your money.
Did you hear the story about the Israeli woman that faithfully stuffed her life savings into her mattress? Over the years she accumulated well over $1,000,000 in cash in her mattress. This was all well and good until her daughter bought a replacement mattress and threw the old one out with the garbage. Who would have thought that a mattress wouldn’t be a safe place to keep your cash?
Strategy and Planning Can Reduce Risk
There are ways to lower the amount of risk you take on any investment.
Just as keeping all of your money in one mattress is probably a bad idea, so is placing all of your money in one asset.
Give a portion to seven, or even to eight,
for you know not what disaster may happen on earth.
– King Solomon (Ecc. 11:2)
Spreading your investment capital into different assets protects you from the risk of losing all of your money in one fell swoop.
If you had invested all of your money in New Orleans prior to Katrina, there is a good chance you would have lost a good deal of your savings. Many investors and homeowners learned the hard way that insurance companies are very particular about the difference between rain damage and flood damage.
Leverage is the ability to control a large asset with a smaller amount of investor funds. With real estate investing this comes by using a loan. The loan may take the form of a mortgage or a note and deed of trust in California.
With leverage an investor can buy multiple properties, reaping the benefits of diversification. For example, imagine an investor plans to buy his properties with 30% down and a mortgage of 70% of the purchase price.
With $100,000 this investor can purchase three (3) properties valued at $100,000 a piece and have $10,000 in hand for reserves. A purchase price of $100,000 x 30% down payment = $30,000.
Purchasing multiple properties spreads the risk of a loss of income over multiple locations. A tree falling on one property will not cause the investor to lose all of their money.
Caveat: Leverage can cut both ways. If a property were to go down in value, the first thing to decrease is the investor’s equity. This is a risk that each individual will have to determine they are comfortable with.
You Can Lose Money, but You Can Minimize the Risk
Yes you can lose money by investing in real estate. You can also lose money while stuffing into your mattress.
We have identified two ways to minimize risk, diversification and leverage. We didn’t even mention buying multiple unit properties, buying below market properties, and other strategies that can minimize the risk of owning real estate.