After the Internet bubble collapsed, many investors pulled out what money remained in their stock portfolios and tried their hands in real estate investment. The theory goes that unlike stocks, real estate is a real asset — a piece of land or a ranch-style house in the suburbs — which can been seen and touched. And a house certainly feels more solid, reliable and dependable than an intangible share of stock.
However, the important lesson from the Internet bubble isn’t that one asset class is superior to another, because you can lose money as easily in real estate as in the stock market. Instead, investors should focus on the issue of valuation. What is a particular house worth?
The calculus for a homeowner and real estate investor is different. Besides looking at the sales price of comparable homes, investors also need to consider how much rent they can collect as well as whether they will be cash flow positive or negative. This is really important. While no one likes to see their assets depreciate, the real estate investor with a positive or neutral cash flow will ride out any market fluctuations more comfortably than the investor with a negative cash flow. No one likes to be chipping in money every month for a house that is continuously declining in value.