Why Traditional Real Estate Investing is Riskier Than Alternative Investing

The Pros Of Traditional Property

Let’s talk about traditional property. I want to say hands down that I love traditional property. It’s certainly how I’ve made a lot of my own personal wealth. I wouldn’t be where I am today if I hadn’t invested in traditional property. This is certainly not a dig at traditional property as a strategy, what I’m really doing is just articulating the contrast from a risk profile between traditional and alternative. So before anyone gets upset, let me just start there.  

If I think about the pros of traditional investing and why I’ve had a long and passionate love affair with real estate investing is number one, I love that it lacks the volatility that things like the share market, crypto, and other asset classes have. 

It is phenomenal for building capital and for building net worth. You can take a small amount of money, go to a bank, get a loan, and leverage your way into controlling a large asset. 

When that asset then creeps up in value every year, your internal rate of return on your original investment is really staggering. 

So there’s no argument from me that from a wealth-building perspective, traditional real estate is hands down one of the most powerful asset classes and significantly more lucrative on average than something like shares or managed funds. 

If I think historically, over the last 50 years, the average multimillionaire today has definitely been able to attribute a large part of their success to the fact that they have invested in real estate.  

There are also a lot of people who say they’ve accidentally become multimillionaires on the basis that they held property over a period of time. What we’re seeing now obviously, is prices starting to become really sky-high.  

And it’s making it harder for the younger generation to access real estate as an asset class in the same way that maybe people who are baby boomers and some Gen Xers might have done, obviously, awesome for tax benefits.  

If you’re an investor of any variety, there’s going to be tax benefits, but there are particularly good ones, such as depreciation and other write-offs, which make traditional real estate very attractive, particularly if you’re a high-income earner.  

And I guess the other major pro around traditional property is that it’s an amazing hedge against inflation.

The Cons and Risks of Traditional Property Investing

I want to really highlight the cons and risks of traditional property and why ultimately, I do feel that traditional real estate is riskier than some of the alternative investments that I undertake. 

So number one, traditional property is terrible for cash flow. You got to wait a really long time. You’ve got to take a 20 to 30-year view on the timeline to squeeze out enough juice from a traditional residential property.  

Now for commercial property, a lot of you will say, “Are the commercial properties better?” It can be better but it comes with its own bag of snakes. 

With the way that the market is evolving, the income streams from even commercial property are getting more and more squeezed.

That’s because as prices rise, wages and income are just not keeping pace so the relative amount of income that you can pay off as rental on those properties hasn’t kept pace.  

So we’re in this situation where we’re hanging on to assets that potentially aren’t going to even be in the back as far as cash flow for several years, and then another decade to 20 years on top of that, before it’s developing meaningful income that you can actually live off. 

There are a lot of investors who experienced this idea of building a great capital portfolio, and then either having to sell down the capital to fund lifestyle, “eat the cow”, as you’ve heard me call it many times or they have to reduce or bring down the cost of their day to day living so that they can live off whatever cash flow those assets generate. 

So definitely, cash flow is a big problem with traditional real estate investing. The cost of entry and exit is incredibly high, particularly in the country that I live in, which is Australia.

The stamp duties, taxes, and other costs of entry, including bank fees, and things like that can really take what might otherwise be a great deal and make it really hard and so what we see in Australia is, there’s a generally accepted wisdom that you buy, and you never sell. 

I think smart investors are starting to see that not only is the wisdom in that methodology not quite right but it also certainly begs the question of if the idea is that you have to hold these assets for a long time, it means that you can’t really put a foot wrong; you can’t afford to hold a lemon in your portfolio. 

Other things are, there are a lot of people who’ve been really turned off real estate investing because they really hate this whole idea of tenants and toilets.

Maybe they purchased an asset that was an older property, had high maintenance costs, or maybe they just got unlucky.

I can tell you countless stories of people I know, who basically had one or maybe two bad experiences very early on in their investing journey and then just wash their hands and just said,

“You know, investing is not for me, I’m just going to focus on paying off my house as my primary investment vehicle and worry about other investments later.”

Then you’ve got this whole raft of problems that comes from having to deal with the banks. 

There are not many people or any people who think it makes sense to plunk down a huge lump of cash and buy a house outright or buy a real piece of real estate outright, apart from the opportunity cost of doing that being enormously high.  

It just doesn’t necessarily make sense financially. Not many people have such high volumes of money sitting around doing nothing. So you’ve got to deal with the banks. 

And the problem with dealing with the banks is they’re getting more and more conservative as we move into these really uncertain economic times about lending money.  

So they’re lending calculators change their criteria change, focus on your income changes, focus on how much you spend on your gym memberships, you know, they want to know everything now.  

What that ultimately means is that they’re really clipping your wings, and telling you in a nutshell, for your income, and who you are in your life, so you can only buy this many properties, which means that the modern-day investing, investing today is really hard in contrast to 20 years ago when it was more about the asset and less about how much you earned.  

And ultimately what that means is that your ability to buy more property is limited. Indirectly what that means is your capacity to diversify is also hampered. You can’t necessarily say “Well because I have a property in Sydney, I’ll go and buy one in another state and therefore I’m diversified,” which is about what a lot of investors have said to me over the years.

It’s that as long as I buy properties in different states that I’m diversifying, but they’re not really diversifying, and it’s becoming more and more challenging as the cost of real estate just skyrockets.  

So that lack of diversification that limits what the banks are prepared to lend us is becoming very problematic for people. 

The Ultimate Reason Why Traditional Property is Riskier Than Alternative

I think the ultimate reason why I see traditional real estate investing as much riskier than the alternative is that you have to rely on a rising market.  

Now, if you are relying on a rising market to make money, you can’t rely on the cash flow. So you’ve got to rely on the capital, what you are really doing is you are speculating that the markets will continue to keep going north.  

Now, if the markets go sideways or if the markets go down, effectively, traditional real estate investors lose. I understand the rationale that the markets have always gone north. So, there’s good reason to believe that they will continue to do that.  

Maybe that will be true. But I guess the point I’m trying to make here is there is whether you think it’s big or small, there’s a risk element around relying on that constant upward market in order to make money. 

The Pros of Alternative Investing in the Property Market

Now, let me switch to how I view this, in contrast to the alternative investment deals that I do. 

First of all, on the plus side, the cost of entry, or exit is nominal, if not close to zero. I mean, obviously, you’ve got some administrative costs. 

But often in the alternative space, you’re not having to wear these things like stamp duty, particularly in markets like the states. 

Part of the reason that that market has evolved into this very entrepreneurial, creative space where you can do a lot of deals and you can make something out of nothing, is because the way that they transact real estate is very creative and it’s very varied. 

They don’t have these crazy stamp duties like the government doesn’t necessarily look at the transacting of real estate as their only source of income, the cost of entry and exit is is relatively low, which means that you can be much more nimble, volatility around cash flow is very low. 

When I first started investing in alternatives, particularly in the US back in 2009, what I saw was, the price of real estate dropped like a stone. 

You were able to buy a good property at 30-40 cents in the dollar. There was a lot of suffering around that, like a lot of people lost their homes, which was terrible, but the thing that kind of boggled me at the time was this idea that rents never did anything that didn’t drop.

That in some markets where rental demand rose because people had lost their homes, rents may have risen slightly. 

I’ve been through many life’s many cycles you know, ups and downs, many recessions, but I’ve never seen anything like what happened during the global financial crisis.  

Like, certainly, if you contrast that to what has happened during COVID, the backlash has been, at this point, relatively minor.  

That’s not to say it won’t change. But what I saw was, there was very, very low volatility of cash flow. 

And what I continue to witness, no matter what tremors there are, economically, particularly when you’re focused on the middle of the road, in affordable housing, the volatility around cash flow is very low. 

If you think about what’s happened during COVID people who lived in maybe smaller, less desirable units and houses stepped up into a better quality of house because they wanted to live somewhere better, while they were in lockdown.  

And those that kind of may have over been living beyond their means stepped down because they wanted something more affordable in a place that they still wanted to live.  

So that middle tier of housing, the median sort of area of the market has done really, really well as compared with low socio-economic housing and super blue-chip, that middle sector of the market. 

So, if we’re focused in that area, then you know, there’s really good, solid predictable cash flow that you can still continue to earn. 

Alternative investing is a strategy or an asset class that allows you to catapult your cash flow.  

So if you’re someone who has historically invested only in traditional property and now you want to diversify into alternative, it’s a way to seriously 5x 10x your cash flow pretty much from day one. 

I work with clients who want to take small bites to the cherry and do it very gradually and typically they can hit a fairly significant six-figure passive income in a period of 12 months to five years depending on how fast or how slow and how much capital they’re prepared to invest. 

But you catapult that cash flow as opposed to the traditional property where you are often waiting 20 to 35 years to produce meaningful income still has great tax benefits, allowing for true diversification.  

Now, I say this all the time, small bites of the cherry, if you can take the same amount of capital and instead of sticking in one asset, you could carve it up and put it into 15 different investment opportunities. 

What that does is it gives you true diversification. You can invest with different dealmakers, different strategies, different liquidity points, different struck deal structures so that you end up creating this really strong blanket of opportunities that are spread, and give you stability in ways that have anywhere from one to up to about five investment properties can never give you because you’ve really got your money tied up in a very small number of assets, that may or may not be geographically spread, that may or may not have the same vulnerabilities to economic ups and downs. 

So crew diversification is something that I love about alternative. If I can take 20 grand or 50 grand and put it in one deal and then take another lump and put it somewhere else and keep spreading the love, it puts me in a much, much stronger position. 

Then we’ve got that hedge against inflation. There are certainly deals in the alternative which give you that hedge against inflation meaning as inflation goes up, rents go up and equity goes up and you get dragged up with it. 

If the market suddenly skyrockets in terms of inflation, and you’re still collecting at a certain rate of interest on a loan that you’ve made, then that’s not necessarily a hedge against inflation, which is where having a good plan and being clear about what you want is super important. 

Alternative Investing is Super Passive

What I love most of all about alternative investing is that it is super passive. Like it is legitimately one of the most passive forms of investing. 

I’m not finding the deals, I’m not managing the deals, I’m not dealing with tenants and toilets, I just sit there with the highest level of control 

I have an ownership or part ownership if I’m investing alongside other investors and I don’t have to do anything other than watch the money distribute into my bank account.  

Obviously, not dealing with tenants and toilets is a huge one and then the final piece, which is really again, the nutshell of why I love alternative is you do not require a rising market and you’re essentially avoiding the need for speculation. 

And if you think of speculation as one of the metrics of measuring risk, how much speculation are you taking, what you are doing, when you move into the sort of alternative investments that I’m talking about is you are buying predominantly for cash flow. 

There are capital deals, but you’re buying cash flow often from day one, you are in, as I talked about a minute ago, a sector of the market, which has little volatility around changing rents, I’m very much trying to avoid ground-up construction.  

Because again, there’s risk around the price of materials and labour and things like that. But I’m someone who has been extremely experimental in my investing career.

I’ve tried at all like I really feel if someone tells me that there’s something to be tried. I’ve really seen myself more as an artist in wealth building, than someone who’s taken a science-based approach.

I want to learn, I want to explore, and I can tell you hands down I haven’t come across any other asset classes that allow you to build an income stream passively that you can depend on.

I’ve witnessed hundreds of people having the same experience and it’s really mind-boggling that when you understand and you have the wisdom, then you can start to really discern this whole idea that we’ve been sold that alternative investing is riskier than traditional real estate is actually a complete and utter myth. Obviously, there are cons as well.

The Cons of Alternative Investing

Well, what are the cons of alternative investing?  

Number one, this is probably the big one, there is not a lot of information out there on them. It’s really easy to get lost in people trying to sell you sexy deals. 

That leads me to my other point, which is that to do well with alternative investing, you need a high level of trust with the deal makers. You need to know like and trust, because you are letting go of day-to-day control over how the asset or assets are managed. 

And the problem with that is that, particularly in markets where there’s a good opportunity to make money, there’s no barrier to entry. You can make money from nothing, particularly in the United States. 

Of course, what happens is it attracts sharks and it attracts want to be newbie wealth gurus. 

The two problems that I see with that are that it’s really easy to get suckered in on good marketing, invest with the wrong people, and trust the wrong people.  

The other part of it is that you can have someone who’s a really good person who makes great sense of deals but then, through lack of experience, or mismanagement screws up. 

Part of the reason that people work with me is they want to inherit some of the trust that I’ve built with my trusted advisor network over a long period of time.  

Just make no mistake though, there are plenty of dodgy people out there. There are plenty of well-intentioned people out there who don’t have the right experience and don’t have the track record.  

The other one is that you need to be really mindful that some alternative investments, once you’re in the deal, you can’t get out until the deal is done. 

Now, that’s not always the case. But if you’re committed to a two-year or 24-month joint venture and that asset is being taken through some sort of project plan, it’s really hard to expect that dealmaker to turn around and give you your money back if you suddenly decide you you need that capital.  

So that’s definitely one way of looking at it but also something that you just need to be aware of. And the other thing is, if you are looking at trying to build capital, it’s really hard to get that same level of leverage that you can achieve in a traditional property. 

Because unless you’re borrowing out of equity from assets you already have, you’re not really leveraging, you’re just putting capital in and then relying on the deal maker to apply leverage in order to get you those returns. 

Comparing Traditional & Alternative Property Deals

If you are comparing a good deal in a traditional property, with a good deal in an alternative, there’s no question in my mind that because of the fact that in the alternative, there is less speculation, this deal works today. It is cash flowing today. 

Yes, I might make improvements to it that will push up its value, create false depreciation, maybe even increase the rents and the cash flow but even if I did nothing, that deal is profitable today.  

I contrast that with the traditional property where I’m buying it today. Maybe it’s giving me a trickle of cash flow, maybe it’s negative cash flowing but I am hoping and praying that the market continues to rise in order for me to make money and I’m weighing those up purely on attributes and trying to decide which one is riskier. 

Just because I’m arguing for alternative investing being on the whole lower-risk prospect than a good deal in traditional real estate, doesn’t mean that’s what you should do right now. It’s really important that as an investor, you recognise where you are on your investing journey and what your actual goals are. 

Like, what are your goals now? If you are someone who needs to build working capital, if either you’re a younger investor, or you’re just getting started, you have to try as hard to squeeze as much juice out of traditional property investing as you can. So that is absolutely where you need to start. 

 And there’s no shortage of people who can help you in that space if you recognise that maybe you’ve kind of either hit a ceiling or you actually are in a position where you are generating good income, and you just want to start building that passive income stream, then alternative is definitely something that you should be looking at. 

You should be understanding what is it, how does it work, does it make sense to you, do you feel comfortable with the risks and the pros and the cons, and all the rest.

Final Thoughts

So for those of you who want to understand more about where you are on your wealth investing journey, I’ve done a lot of this in terms of the three parts to the wealth game. I think Episode 63 covered that in a lot of detail. But please go back and have a look at those. 

If you have any questions about this stuff, please reach out to me. I love a robust and playful debate. I’m certainly not trying to offend anyone and I definitely recognise that both traditional and alternative have their place.  

But I really genuinely feel that this idea that particularly people who don’t understand alternative is that they’re saying it’s risky and you shouldn’t touch it is just completely sending you down the wrong path.  

I know I got into the weeds a bit but this is really important stuff, and I can’t stress enough the number of people whose lives have been totally transformed by taking a small percentage of their portfolio and putting it into alternative simply because the cash flow is reliable and they can bank.

If you’re a business owner feeling frustrated that despite doing everything right in the property investing playbook and you’re no closer to financial freedom, then head over to www.inkosiwealth.com to learn more about how you can use alternative investments to catapult your investing income and blend strategies to shave decades off your timeline to financial freedom.

If you’re interested in understanding how to create wealth through alternative strategies,  please check out my programs, where I help you catapult your investment income and blend strategies to shave decades off your timeline to financial freedom.Or, you’re welcome to get in touch today, book a call with me, and I would be happy to talk you through it – no obligation!