Skip Investing in Rental Properties, Advices a Fintech Company that Manages More Than $22 Billion Worth of Assets

Ten years ago, John Paulson, the investment genius who’s made a mountain of money by shorting subprime mortgages a few years back, peered into his crystal ball and told New York’s University Club to invest in real estate.

The multibillionaire hedge fund operator said that those who don’t own homes should buy one and that those who already own homes should buy another one—more, if possible.

Today, the winds seem to have changed direction, at least as far as one fintech company is concerned. Wealthfront, an investment management company that has around $22 billion under management, is advising people to do the opposite of what Paulson said a decade ago. In a blog post, Wealthfront co-founder and CEO Andy Rachleff said that perhaps the most common piece of advice that people hear from either their financial advisors or the people around them is that, from an investment perspective, rental properties are the safest route to take. But Rachleff says that this is only good advice for a fortunate few—for the rest, it’s terrible advice.

As to why this is so, below are the reasons Rachleff gave—and anyone who’s been toying with the idea of investing in rental properties should give these four reasons some attention.

No guaranteed income. Real estate, especially real estate rental properties, will need some time before generating profit. This means you’ll be seeing losses each year—losses you’ll end up needing to fund.
Returns are hard to generate: It takes a lot of time for an investment property to create a return on one’s investment. This is simply because it is hard to charge high enough rent in this current environment to be able to offset costs as quickly as they would like to consider the investment worthwhile.
It’s difficult to diversify—and diversification is the most critical: Most people feel drawn to the allure of getting a good deal on an investment property. A seemingly good deal will always feel like a good investment. While this may be true in an upmarket, we’ve learned in 2008 that an undiversified real estate portfolio carries with it enormous risks.
Real estate isn’t liquid, and “liquidity matters”: “Unlike a real estate index fund, you cannot sell your property whenever you want.” It will be tough to predict, after all, when the value of the property becomes good enough to sell. Most investors require a 3% to 5% annual return on their investment to justify the decision to hang on to it. As far as the state of the market is concerned, it’s difficult to tell whether one can be assured of those kinds of returns from a real estate property.

[Photo Credit: Bill Lapp/Flickr]

Rachleff will readily maintain that rental properties should remain a part of one’s portfolio, but it should be treated as “play money,” so to speak, amounting to only 10% of one’s liquid net worth.

Naturally, every rule has its exceptions, and Rachleff does have an interest in convincing prospective real estate investors to divert their money to the stock market instead. Still, whatever the case may be, he calls tinkering with rental properties a risky proposition, especially when there are other, more lucrative avenues in which to take your money and investments.

Based on Materials from MarketWatch

Photo Sources: Bill Lapp, Flickr