We cover five pillars: Financial psychology, Increasing your income, Investing, Real estate, and Entrepreneurship. It’s double-ii FIIRE.
Today, we’re diving into Pillar Four: Real Estate.
Pillar IV | Real Estate
Whew. Welp. Where do I begin?
Over the last five years, home prices nationwide have grown at an annualized rate of 8.67 percent, according to the S&P CoreLogic Case-Shiller Home Price Index.
If you owned a rental property, that means you made some absolutely banger returns.
Remember, assets grow value in two ways: appreciation plus the dividend or income stream.
If the appreciation is 8.6 percent, and the dividend — represented by the cap rate — is (conservatively) another 5 percent, that means your total unleveraged returns would be an annualized 13.6 percent.
The keyword there is “unleveraged.” If you borrowed money to get into the deal, you would be doing even better, based on cash-on-cash return.
(That said, be cautious about drinking the cash-on-cash Kool-Aid.)
So we’re in this weird position today.
Homeowners, especially those who bought pre-pandemic, are sitting on strong equity gains. And three-quarters of homeowners with mortgages have interest rates that are below 5 percent, which means they have both equity gains and a low-interest loan that, in recent times, has been cheaper than the cost of inflation.
(There’s also a significant portion of homeowners without mortgages — predominantly Baby Boomers).
That means existing homeowners are wondering: What should I do with all this equity? Should I tap it? Should I buy another property? Should I start a business? Should I put it in the market?
Meanwhile, people who didn’t buy homes in the last 15 years are wondering: Is it too late? Will I ever get my chance? What should I do?
Sometimes the best way to tackle big, broad questions is by zooming in on specific situations.
Let’s get practical and look at common applications of these questions in real life.
Q1: My friend keeps telling me I should wait for a housing crash to buy my first home. Are they right?
No.
They are very, very wrong.
Crashes don’t happen simply because the market is high. Crashes happen when there’s fundamental weakness in the system, such as overbuilding and overleverage.
We saw this in 2006, and critically — at the time — we had not only excess leverage, but also mispriced leverage.
We don’t see this type of weakness in today’s market. An astonishing 40 percent of US homeowners don’t have mortgages (which means they hold minimal risk of foreclosure), a significant jump from the 33 percent of US homeowners who were in this same position in 2010.
Those who do hold mortgages are better qualified, with lower debt-to-income ratios and higher credit scores.
And when those loans are packaged and sold in secondary markets, they’re more accurately priced.
Meanwhile, we have a severe housing shortage across the U.S. The Chamber of Commerce estimates that the shortage is 4.5 million homes nationwide, although the severity of this varies based on region, state, and city.
Many areas that have had high population growth have not had construction that can keep up, especially in the realm of single-family.
The obvious follow-up question is: “If there’s an incentive to build, then why aren’t builders building? Shouldn’t the laws of supply and demand take care of this?”
The issue is that many areas have highly regulated housing markets, as defined by the Wharton Residential Land Use Regulation Index.
These areas tend to suffer the biggest housing supply shortages. A recent report from Zillow states:
“One indicator of housing affordability is how strict a region’s land-use rules are, new Zillow research shows. Those who live in highly regulated housing markets … are less likely to be able to afford the mortgage payment on a typical home in their metro, even in markets with higher-than-average incomes. This is because housing supply persistently falls short.”
These types of regulatory barriers require a long time to unravel — if they ever do — and as a result, we are likely to be stuck with a housing supply shortage for many, many years to come.
Finally, one element that brings stability to home prices are the underlying costs of labor and material that go into a home.
These prices have jumped significantly in the past several years, with lumber, wood, copper, and labor costs all spiking post-pandemic.
So, no, please do not “wait for a crash” before you make a move. Anyone who advises that is leaning on hope rather than data.
Q2: I want to move but I’d lose my 3 percent mortgage rate. Should I keep my current house as a rental instead of selling?
It depends on the cap rate, which is functionally the dividend or income stream from the property. Here’s an explainer on how to calculate cap rate.
Once you crunch that number, you’ll have a sense of the dividend payout that you’ll get from the property.
That dividend payout, plus the appreciation on the property, is your unleveraged return on the property.
How much is the appreciation? You can conservatively estimate this as keeping pace with inflation, so around 3 percent, although historically nationwide, home values have risen at 5 percent as a long-term annualized average.
Pick either number (3 percent or 5 percent) depending on whether you want to be conservative or aggressive in your appreciation projections.
So: Your cap rate plus your appreciation estimate is your unleveraged return. Once you crunch this number, ask yourself: is this a return that’s worth hanging on to?
Q3: Since so many buyers are sitting on the sidelines right now, are you seeing better deals pop up? What should investors be looking for?
Yes. Broadly speaking, look for properties in the suburbs and exurbs of major cities, which are some of the fastest-growing and most in-demand areas, particularly in the Midwest and South.
That’s a generalized statement, and I want to give the caveat that all real estate is local. There’s no such thing as the national housing market. There are simply many, many local markets, and what’s true in San Diego is not going to reflect the realities of Wichita.
Speaking broadly, I would be looking at cities that have:
(1) great price-to-rent ratios
(2) net population growth
(3) a variety of industries and employers
(4) proximity to an airport and interstate highways
My favorite examples right now are Indianapolis, Columbus, and the very, very outer suburbs of Atlanta (so far out there that it’s really just Georgia at that point).
I can tell from the number of unsolicited phone calls that I receive that Las Vegas is hot right now (no pun intended), although its over-reliance on one industry has always made me a little nervous. But that hasn’t stopped many investors from making great money there.
I haven’t personally studied the Northeast markets that well, but I have several students in my course, Your First Rental Property, who have done very well in this region.
Q4: For people debating their first home purchase in 2025, how do you think about rent versus buy in this environment?
Calculate the price-to-rent ratio (P/R ratio) by dividing the home price by the annual rent.
If you live in an area where the P/R ratio is 15 or under, buy.
If you live in an area where the P/R ratio is 25 or over, rent (unless you house hack).
If you live in an area where the P/R ratio is between 15 and 25, you’re in a gray zone.
Renting makes a ton of sense if you’re looking at properties where the P/R ratio is over 25.
And if that ratio is over 30 or 35, renting is a slam dunk no-brainer. The only exception would be house hacking.
Q5: If someone’s renting but wants to eventually invest in rental properties, should they buy their own place first or skip straight to investment properties?
If you live in a city with a high P/R ratio, remain a renter for your primary residence (unless you house hack) and skip straight to buying investment properties in parts of the country with owner-friendly P/R ratios.
I have good friends right now, a recently married couple, who rent in Astoria, Queens, New York and are about to purchase their first rental property in Cincinnati.
This is the most financially savvy way to get on the property ladder.
