One common debate any person with an interest in building wealth has with themselves is saving vs investing in real estate.
Which is better depends a lot on your age, financial situation, and your plans. If you are expecting a story from Mashvisor saying that saving money is crazy and investing money in real estate is the only smart move, read on.
There is no debate that you must make your money work for you. If you are already actively managing your money, you are on the right path. Considering saving vs investing in real estate means that you are forming a strategy. Making money is the overall goal, but there is a time when it’s best to save. Here is Mashvisor’s guide to saving vs investing in real estate.
Saving Money vs Investing in Real Estate – Manage Risks
The single most common reason any small business fails is lack of capital. What does that really mean? It simply means that those who participate in real estate investing sometimes need more cash savings than they have. Losing money temporarily in any business is a fact of life. Real estate investing comes with risks. One way a smart investor manages those risks is with savings.
Related: 5 Risks in Real Estate Investing and How to Limit Them
You need to have enough savings in your personal finances to cover periods of uncertainty, change, or bad luck. Real estate investors need savings for the same reasons. Credit can help you in many short-term situations, but there will be times when you need to have a cash reserve to pay for things that hit you unexpectedly.
Credit has a cost. If you are relying on credit to make predictable repairs and maintenance, you are only hurting your return on investment. Every real estate investor knows the common maintenance and repairs that will be needed on their investment properties and they plan ahead. Savings enable real estate investors to manage these predicted costs. The cash acts as a buffer to your inflow and outflow of revenues. Use credit cards and equity loans to manage the outflows and you incur a loss of profits. Use cash and you avoid the cost of credit.
Saving Money vs Investing in Real Estate – Opportunity Costs
Another benefit to savings is to be ready to capitalize on opportunities. Having a solid cash reserve enables a real estate investor to jump on deals a person without cash cannot. As it turns out, this happened in your author’s real estate business this month. One of my six units was about to be listed for sale. Within my network, I let it be known that I was about to engage my agent in the sale. Before I listed it, I made it available for direct sale without a realtor. By dealing directly with a buyer, we would both save the realtor’s commission. I could sell the house for tens of thousands less than if I had to use a realtor.
One of my contacts expressed great interest. He was looking for exactly what I had to offer. Unfortunately, the sale fell through because the buyer didn’t have enough cash to make the deal work. The irony is this buyer has more overall wealth than I do. He owns dramatically more real estate than I do in terms of dollar value. But he had tied up all of his money in investments that were not liquid. In other words, in the world of real estate, saving actually enables investing in real estate in some cases. Striking the right balance is the key to success in many deals. By investing his wealth too heavily in his existing high-value real estate, this buyer left himself without enough cash to cover a simple deal on an entry-level property.
Saving vs Investing in Real Estate – Inflation Erosion
Missing out on deals is one side of the debate over saving vs investing in real estate. Here is the flip side. Many savers feel great when they look at their growing balance. Online savings accounts have been offering up to 2% in interest over the past couple of years. Save $100,000 and you “earn” $2,000. With zero risk! Actually, you lose money steadily.
There are two reasons that saving money in America means a loss in principle. The first is inflation, or the declining value of the dollar. Everyone in America wants a “cost of living raise” every year, and for the most part, they get it. That causes inflation. The dirty little secret about the growing cost of living is that it is driven by cost of living wage increases. Inflation eats at your cash savings by eroding the value of the invested dollar. What is the rate of inflation? It is always just above the rate of interest on a savings account.
Saving vs Investing in Real Estate – Part Two – Taxes
In addition to inflation eating up your $2,000 in paper “earnings,” taxes do further damage. Anyone who earns a decent wage in real estate investing will be paying 20% or more in income taxes. So, in addition to your savings being negated by inflation, taxes are going to mean your true savings are actually negative, not positive. High-earners in America can pay as much as 40% in income taxes. Your $100,000 in savings is declining by up to $400 in value each year after taxes and inflation. Does this mean you should never save cash? No, it does not. Just don’t lie to yourself about interest earned on savings.
Relates: Real Estate Taxes: Everything a Beginner Investor Needs to Know
Saving vs Investing in Real Estate – It’s All About Balance
There is never a single right answer about whether saving vs investing in real estate is the best move. What matters most when asking this of yourself is your situation. Have you just extended yourself to acquire a new duplex investment? Are you now normalizing your cash flow having just renovated the new units and rented them? Now is the time to start to save money again to be prepared for a downturn or the next opportunity.
Conversely, has your investment portfolio matured? Do you have significant equity and a stable flow of cash from multiple sources? If so, this is a time when it’s best to invest in real estate. You can invest by acquiring a new property. In addition, you can invest by doing upgrades to your existing investment properties to make them rent for more money and build equity. You can even invest in your own business by paying down debt. It’s financial insanity to park cash in a savings account at under 2% interest while having a mortgage or equity loan at 5%. Save by paying down debt if you have enough cash on hand.
Related: Diversification and Real Estate Investing: 3 Ways to Diversify Your Portfolio
Saving vs Investing in Real Estate – Not Your Only Choices
Real estate investors are in the business of real estate, so they already check off the property box in their personal wealth management plan. The best way to invest personal money for a real estate investor may be outside of real estate. Stocks and other equities are an important part of an overall portfolio. These are risky. Insurance policies with a cash value are another option. These are a super-conservative option. Mutual funds and time-targeted funds strike a balance. As an individual, you need to be in all forms of investing.
There are many benefits to real estate investing. We here at Mashvisor focus on them in our daily guides. However, there is no single best way to invest money. As we have shown, there are benefits to saving money that eventually circle you back to real estate investing opportunities. The most important thing you can do is plan your investments and get help from advisors.
Should the stars align and point you to acquiring real estate, Mashvisor is ready when you are with all the tools you need to find, evaluate, and buy investment property. Click here to get started now.
Author Note: John is not a financial advisor. He is a real estate investor.