Use Settlement Money to buy Real Estate?
Dear Dr. Don,
My husband and I are in our early 30s, and we have a young child. We both work full time with a combined annual income of about $120,000. We own our own home and have a sizable mortgage with monthly payments we can afford. I received a $250,000 settlement from an accident. My husband wants to buy investment property with the cash. I have some concerns about buying real estate without carrying a mortgage at our age. Please advise us on what forms of investments we might consider.
I do not want the money to sit in some account earning virtually nothing in in interest. The idea is that we should be wise in putting the money to work.
Thank you,
-Denise Denouement
Dear Denise,
I think most people have more than enough money invested in real estate with the investment in their personal residence. There is money to be made in investment properties, but the problem is that one can be too highly concentrated in one asset class. That's especially true if one is to double down by buying properties in the same community.
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Do you have a competitive edge in property management, or are you just like the rest of us? Are you able to handle the inevitable repairs that crop up? I used to own a flat when I was younger and remember hating to fix the tenant's unit. Sure, you can hire a property manager and a maintenance team, but that subtracts from your potential profit. My own real estate exposure, outside of my residence, is in publicly traded real estate investment trusts, or REITS, but I'm not recommending that to you here.
Think about what you want this money to help you accomplish. You should also consider your attitude toward risk. Look how at the rest of your net worth is invested when deciding how to commit your settlement funds.
If you do decide to buy investment property, I'd suggest working with your accountant to make decisions about depreciation and financing. Another question is whether you will be a passive or active investor in the properties. Basically, you would be a passive investor if you're not working regularly in the property management business. This classification limits your ability to deduct losses in your real estate investment portfolio. On the financing question, it likely does make more sense to buy an investment property using a mortgage rather than paying cash.
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