Why do so many business owners buy real estate? Usually, when I am reviewing the total assets of a business owner, inevitably, they own real estate outside of their home. That could be residential or commercial real estate, and usually more than one. While real estate is one of many investments, some owners value the perceived control, familiarity, and tangible aspects of real estate. Even if it may not produce the best returns, owners feel drawn to include it in their wealth.
Sense of Control
Small business owners usually define risk differently from most people. I read a great book recently by Ali Nasser that nailed this subject, called Business Owner’s Dilemma. Ali explains how business owners who have more control of their investments have a lower perceived level of risk. Having the ability to change, modify, and grow their company usually provides business owners with more perceived safety than other investments.
This explains why business owners are comfortable putting their entire net worth into their small business. You may have thought before, “Why would I put my money in the stock market when I can just grow my own business?” Ali hammers this home by juxtaposing two investors, one whose net worth is entirely in $50 million of stock in Apple and the other whose $50 million of stock is in their own business. Everyone would tell the former investor that they are insane and must diversify. While the latter would receive praise and congratulations for the success of their “small” business.
Therefore, risk is fundamentally subjective. Risk must apply to your specific goals, objectives, timeline, and risk tolerance. The investment industry focuses so much on this because investments cannot be objectively measured independently of the investor (no matter how hard we try). For example, investors decades from retirement who put their retirement funds in a savings account are extremely risky. Not in the traditional sense of the risk that the account value decreases, but that you miss out on decades of growth to reach your financial goal.
On Real Estate
Owners are typically drawn to real estate for a few reasons. First, it is more than common for business owners to own property as part of the business. That could be the office building they are in, or the warehouse where the operations occur, etc. Owners usually have more experience buying/selling real estate, as well as paying rent for properties they don’t own. From an investment perspective, it is relatively easy to see how purchasing additional properties as part of their personal net worth would have a similar result.
The second reason is the level of control that real estate requires compared to other investments. Because owners have a fundamental need for control, looking for other investments outside of their business that provide control is enticing. Every now and again, I get the question, “Should I sell or rent out my house after I move? My answer usually falls along this reasoning. If you never want to be involved as a landlord, or manage contractors/property managers, or expand to multiple rentals, then it likely may be best to sell the house and move on.
The third reason, while less scientific, may be the most influential. Business owners buy rental property because they hear and see other owners doing so. While stocks or bonds are intangible, rental properties physically exist. Many times, in investing, people want to follow what they perceive the crowd is doing because there is safety in numbers. If owners understand real estate, value the degree of control it provides, and see other owners doing the same, they may be more inclined to invest.
Making Money
Generally, there are two ways to make money with an investment. Either you hope for the market value to grow before you sell it, or you hope the investment will pay out income for as long as you own it. Some investments focus specifically on one or the other, while others are a blend of both. When you own a rental property, you expect to receive the rent from the tenants. Then, when you are ready to sell the property, you hope the market value has increased since you bought it.
From a purely rate-of-return perspective, real estate investing may not always be the most efficient use of capital. One of my favorite economic principles is the concept of opportunity cost, or the cost of not choosing the next-best option. There will always be a better investment with a larger return. By definition, diversification is a planned opportunity cost. Owning a business, rental properties, gold, stocks, and bonds can be well-diversified, even if you are forgoing the return of your money all in one asset class.
However, the other component to investing is the time required. I would argue that building a portfolio of rental properties is an entirely new business to handle. If you want to run and manage another business on top of your other ventures, then real estate investing can be successful. Regardless of the opportunity cost, rental properties can help supplement your overall balance sheet. But if your goal is to minimize your time and focus on returns, other investments like stocks can be significantly more attractive than real estate.
Everyone Likes Real Estate
Real Estate investing will never go away. As long as the Earth is still here, people will buy and sell property to increase their wealth. Many people have built a life in real estate, but it is important to understand why you are doing so. Real estate provides owners with a sense of control that stocks may not, but the specific reasons need to be addressed. If diversification away from the business is the goal, rental properties may be a great investment. If maximizing return and minimizing time is the goal, then at least you now know real estate may not be the answer.
TC Falkner 