Conventional wisdom has long held that investing in rental real estate is a reliable means of accumulating wealth. For many investors, that has certainly proven to be the case. But for every successful landlord, there are probably dozens of landlords who lose money – and lose it spectacularly.
I can say this with confidence because I’ve seen it firsthand. Roughly a third of the hundreds of security clearance denials and revocations my office handles yearly involve financial issues; of those, a considerable number include a foreclosure or short sale of real estate purchased for rental income.
Before Buying an Investment Property, Remember Murphy’s Law
There are a variety of reasons for this phenomenon, but the most common seems to be first-time investors who, in a commendable effort to secure their retirement, bite off more than they can chew financially by purchasing a duplex, triplex, or multiple single-family homes. The rental income potential appears attractive at the time of purchase, but the buyer fails to adequately consider or budget for associated costs like repairs or vacant units – all of which increase exponentially the more rental units are owned. In short, buyers are blinded by potential and fail to consider Murphy’s law: if something can go wrong, it will. And if something can go wrong with one rental unit it can go really wrong with multiple units.
That’s not to say that investing in the rental property market is never a risk worth taking; it simply means that prospective landlords should start small, grow their property portfolio slowly, and plan (i.e. budget) for worst-case scenario before signing on the dotted line. For security clearance holders, that due diligence is particularly critical. If financial troubles later appear on the horizon, being able to demonstrate that you acted reasonably and responsibly can mean the difference between keeping and losing the government’s confidence.
Clearance Holders Should Consider Investments that Hedge their Potential Losses
But before doing any of that I recommend that security clearance holders – frankly, anyone – considering investing in the rental real estate market consider an alternative that sometimes gets an undeserved bad rap: the stock market. By most measures, investments in a broadly diversified index fund have historically out-performed virtually all other investments. Of equal importance, investing in the stock market is inherently limited by the funds that each investor actually has at his or her disposal (unless buying on margin, which is a bad idea for the average investor). That means that the most an investor has to lose is what he or she actually invested.
On the other hand, a real estate investor stands to potentially lose their entire investment and then get socked by a deficiency judgment in some states if there is a difference between the amount owed on the note and the price obtained for the property at a foreclosure auction. Those deficiency judgments can be five or six figures and we’ve seen creditors pursue them. Finally, a stock market investor – particularly an index fund investor – is unlikely to lose the entirety of his or her investment; but there is no middle ground between keeping a rental property and losing it to foreclosure.
Ultimately, the decision of whether or not to invest in the rental real estate market is one that must be made on a case-by-case basis. For investors with disposable income who have really done their homework, it may make perfect sense. As with any investment, however, just be sure that you’ve adequately considered the risks along with the rewards.
This article is intended as general information only and should not be construed as legal advice. Consult an attorney regarding your specific situation.