Smart Investing

If you are a regular reader of my column and or a listener of my radio show, you know that for the past year I've been optimistic on investing in equities -- and it has paid off well over the last 12 months.

Many times at cocktail parties or dinner parties I'm asked if I think real estate is the better investment over equities. Let me give you some of my thoughts and you can make your own decision on what you think.

About a week ago, I was in a restaurant and a women began talking to me and the conversation quickly moved to a brief discussion on investing after she said she had heard my radio show a couple of times on KFMB AM 760. She was excited because she had just purchased a property that was half of what it was just a couple of years ago. She couldn't wait to tell me that in a couple of years, the property will go back to where it was a couple of years ago -- and she will double her money.

Well, my kids were getting hungry and they hate when I talk business or investing -- they think it is boring, obviously because they have no money to invest -- so I just nodded and let her think that I agreed with her. I'm sorry I took the easy way out, but you know how relentless kids can be when they are bored.

While I didn't have the time to explain all the details then, I do now. First, one must look at what caused the big increase in real estate up to the decline starting in 2007. As any investment increase, high demand will push prices up. But what caused the high demand up to the 2007 decline? Loose, very loose, lending practices. There is no doubt in my mind that we won't be returning to the loose lending standards anytime soon; I would guess and hope at least 10 years. So unless investors have a lot of cash to buy some real estate, they still must go through the banks.

I've heard so many times in my life about how this person bought a house for $100,000, 20 years ago, and now it is worth $300,000 -- what a great investment. But just like I dig deep into the numbers of the companies I invest in, one should do the same when investing in real estate.

First, on that property there are property taxes; if you live in California they're around 1.1 percent, depending on where you live, and could be higher in other states. From that $200,000 gain, one must deduct the property taxes paid over the 20 years. Another expense that is left out of the equation is the cost of insuring the property. This is another cost that over the 20 years has increased dramatically, and if one had any claims, well, you know what that would do to the insurance premium.

I've lived in my current home, which we bought new, just over 10 years ago and things are starting to breakdown. Pipes are breaking, stoves are dying and carpet is wearing out. These repairs must also be totaled and deducted from the $200,000 gain. If you're like me and you have the tool box to do the repairs, you do your best -- but you end up calling Ron the handy man to fix what I "fixed" -- be sure to add in those costs as well. When you add them up, sometimes these can be substantial.

Normal maintenance is another expense that must be deducted as well, such things as landscaping, painting, and cleaning of rain gutters or air ducts and air filters can reduce your overall gain.

If you're like most others, you did have to finance the purchase and pay the bank interest for the use of its money. While this is deductible, it is not 100 percent deductible; in other words, if your interest is $10,000 per year and your tax bracket is 35 percent, you still had to pay $6,500 out of your pocket.

If you are renting out the property, there are tax benefits and cash flow that can help increase your return -- but make no mistake, you are a landlord and you will be getting calls to fix this or fix that on your property. If you hire a property manager to handle this for you, be sure to deduct those costs over the years out of your gain.

Lastly, when you do sell that real estate, you will be responsible for the capital gains tax, and if you're renting the property you must recapture the depreciation. Yes, I know one can do exchanges, but there are limitations there as well. When you sell that property, there will be selling commissions that will have to be paid; whether they are 5 percent or 6 percent of the selling price, be sure to deduct that from your $200,000 gain.

So is equity investing better than real estate investing? Every situation is different, so be sure to spend the time to do the numbers, whether investing in real estate or equities. Please don't assume that real estate always goes up and stocks always go down; there is so much more to analyze.