If you're considering investing in real estate, you should be prepared to make a long-term commitment.
While it's sometimes possible to buy a property and flip it quickly at a profit, this can be a risky approach. And it's unlikely to pay off unless you know the local market very well, time your purchase perfectly, and are prepared to put in some sweat equity to help ensure the property appreciates before you sell.
In most cases, however, you're far better off treating the purchase of any property as a long-term investment, whether you're buying a house to live in or a space to rent out. Here are three big reasons.
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1. The investment is illiquid
Physical real estate is not an easy investment to move in and out of.
With many other assets, such as publicly traded stocks, cryptocurrencies, or even physical gold or silver, there's generally a ready pool of potential buyers available. One particular share of a company, virtual coin, or piece of precious metal is typically as good as any other of its kind, so it's relatively easy to find someone to purchase the asset with minimal effort on your part.
That's not the case for a home or investment property, though. When you list a building or land for sale, it's impossible to know how long it will take to find a qualified buyer interested in that particular piece of real estate. It could take weeks, months, or even years to find the right person -- even if you're willing to sell at a loss because you can no longer afford the costs of ownership. And if you're able to quickly find a buyer, the logistics of completing the transaction can mean it takes several weeks or months until ownership changes hands.
If you want to be able to quickly access your money and ensure you're able to unload an asset on your desired schedule, buying physical real estate is the wrong investment. But if you have a long time horizon for ownership, it likely won't matter as much if it takes you time to find the perfect person or entity to sell to in the end.
2. There are high fees
When you buy and sell physical real estate, you can expect to pay closing costs that typically equal as much as 2% to 5% of the value of the asset -- or more.
You may need to pay a real estate agent's fee as a seller. You'll likely have mortgage origination costs, appraisal fees, and inspections and surveys to pay as a buyer. There's also title insurance, pro-rated taxes and association fees, and transfer taxes to consider for both buyers and sellers.
When you incur thousands of dollars in costs every single time you buy or sell a property, you need to make a fairly substantial profit just to break even. That's much more likely to happen if you intend to own the property for a long time since it can take years for the asset to appreciate enough that you cover transaction fees and break even.
3. Capital gains could be much higher if you sell quickly -- and can sometimes be avoided entirely if you hold for the long term
Finally, if you sell a property quickly, you could end up paying short-term capital gains taxes on any profits. Owning an asset for less than a year and selling it at a profit means you'll be taxed at your ordinary income tax rate on any gains.
If you can keep the property for longer than a year, however, you'll be taxed at the long-term capital gains tax rate, which is generally much lower. And if you both own and use the property as your primary residence for at least two of the five years before selling, you can typically exclude a substantial portion of your gains entirely and pay no taxes on up to $250,000 in gains as a single filer or $500,000 as a joint filer.
For all of these reasons, it's worth thinking about whether you're willing to make a long-term commitment before buying real estate. If you don't plan on investing for the long term, think seriously about the the downsides and risks of short-term ownership and consider getting exposure to this asset class via other methods rather than buying physical real estate.
