4 Reasons Not to Buy Into the Real Estate Hype

If you follow any mass-market finance gurus, you’ve probably seen content touting the merits of buying physical real estate—to generate rental income, fix up and flip, “house hack,” or buy into growing demand for self-storage facilities, for example. At last count, there were more than 10,000 books focusing on real estate investing available on Amazon.com.

Real estate proponents point to a few positives: a reliable monthly income stream, the potential to generate wealth over time, and the freedom to manage your own schedule instead of working a full-time job.

The sheer amount of hype surrounding this topic is one reason to be skeptical. But there are at least four other reasons that real estate investing might not be a sure thing for everyone.

Reason 1: It’s a lot of work. Buying real estate is often described as a way to generate passive income. But in most cases, there’s a lot of sweat equity involved. That’s especially true for people who buy into multifamily properties and rent out apartments. Owners need to keep up with painting, plumbing, appliance repairs, and occasional middle-of-the-night emergency calls from tenants. It’s possible to outsource some of this work to a property management company, but that involves extra cost (averaging about 8% to 12% of the monthly rental cost) and still requires oversight. Maintenance costs can add up, too. Most real estate investors recommend budgeting at least 1% of the property value for annual maintenance and repairs, if not 2% or 3%.

Reason 2: Real estate is illiquid and has high transaction costs. In some markets, it can be as easy to sell a home, apartment building, or commercial property as it is to buy, but that’s not always the case. During periods of higher interest rates or economic weakness, it might take much longer than usual to offload a property. For example, the median time on the market for homes in California usually averages about three weeks when the economy is doing well, but that extended to nearly three months when the state went through an economic slowdown in the early 1990s.

And there’s typically a hefty cost involved for real estate commissions and other closing costs. Real estate commissions have typically averaged around 5.5%. That number might decline now that the National Association of Realtors has agreed to a settlement to resolve numerous class-action lawsuits, but transaction costs will probably remain significant.

Reason 3: Buying real estate near your home can leave you overexposed to negative market conditions in a specific city, state, or region. For practical reasons, most real estate buyers focus their purchases on areas close to home. That can leave them more vulnerable to regional downturns. For example, Austin, Texas, was previously one of the hottest real estate markets in the country. Prices surged by about 60% between 2020 and 2022. Since then, home prices have dropped by about 11%—more than any other metropolitan area in the US.

Reason 4: Tax issues can be complicated. Income from rental property is taxed as ordinary income, but owners are required to take an annual depreciation charge against the purchase price, which can partially offset the tax hit. If you end up selling a rental property at a loss, you can’t use this to offset other income, such as wages from your job or dividends and interest from your investment portfolio. Real estate investors can typically sell one property and roll the related capital gain into a new purchase (also known as a 1031 exchange) instead of recognizing it as a taxable gain at the time of sale. All of this is complex, though, and it’s easy for novice real estate investors to get tripped up by the details.

Conclusion

None of these issues is insurmountable if you’re willing to put in enough time to learn the ropes and avoid the pitfalls. Real estate income can be a nice supplement to retirement income or a way for “financial independence, retire early,” or FIRE, adherents to generate passive income. But given the hype factor I mentioned earlier, it’s especially important to proceed with caution. The internet is rife with passive income boosters who often have a vested interest in selling pricey online courses to real estate newbies. For a more sensible approach, I’ve found the free articles on The White Coat Investor to be helpful. The site targets physicians, but most of its content is relevant for people in other occupations. And as always, Bogleheads.org is an oasis of sanity for discussion of real estate’s potential risks and rewards.