Lump risk – the issue with Real Estate

In Germany, everybody wants to own a house. Owning your own house or at least apartment is always considered the save bet and what most people invest their money in. People with higher income additionally consider to buy further properties, either apartments or houses that they can rent out to make more money.

In general, real estate investments are not a bad idea. The earth’s surface is limited in size so on average the value of a plot should increase over time. This is of course only true as long as the population size does not decrease in the city or region in which the plot is located. That means buying a more expensive apartment in a growing city or at least in a growing region is better than buying in a region with decreasing population size because these trends cannot quickly change but are rather stable over decades. Nevertheless, while population size is to be considered, you can consider it easily and it is not the issue that I want to focus here.

The real issue with real estate investments, if you buy a single house or apartment, is the lump risk. Even the cheapest apartments or houses (at least in Germany) usually cost 50K EUR or in growing regions or cities, where you want to buy 200K EUR or more. This means you have to invest a huge amount of money in one specific endeavor. And even if you can buy a house or apartment for “only” 15K EUR or 20K EUR this is still a lump risk.

But what is the risk? Why could real estate be a risky investment? Well, now you maybe rent out this place that you bought. If you do not rent it out, you cannot make any money of it. In worst case the person that rents the place from you does not pay the rent. Given the German laws which are always in favor of tenants, you cannot even get rid of the person or family that does not pay their rent.

This means you lost all returns from your investment because you cannot invest the money somewhere else and in worst case you might still have to pay the house money (“Hausgeld”) for the services that the apartment or house needs. Even if you do the services of the house yourself, you are still stuck with the taxes on the apartment or house. Of course the tenant should pay all of this but you cannot do anything if they don’t pay it. This means in worst case you do not only make no money on your huge investment, you can even lose additional money. Maybe you need to hire a lawyer to get rid of the tenant. Maybe you will have to renovate the ruined apartment or house after the tenant was finally thrown out by the police.

And you can imagine that I would not tell this story if these things would not have happened to me in the past yet.

All of this is less of a problem if you have several million EUR because then you can buy several apartments and spread the risk. In that moment, you do not have a lump risk anymore.

Or maybe you are a perfect judge of character and would never get a bad tenant. In that case the risk of getting a bad tenant is lower but it is still a lump risk, an entrepreneurial endeavor. It is not an investment generating cash flow while you sleep.

Another solution is using REITs or simply investing into companies. REITs are real estate investment trusts, as the name says they are trusts which have many apartments and rent them out for you. So you don’t have to do anything. They are traded as stocks and you can make money while you sleep. Or you just invest in normal companies. Many companies anyway have real estate so it is directly a part of your investment. You can do this simply by buying single stocks or ETF. And ETFs are by definition the opposite of a lump risk.

The biggest issue, at least in Europe, regarding investments in real estate is that it is a status symbol and people feel forced to buy real estate because it is “such a good investment”. And yes, it can be a great investment, if you are wealthy already and want to spread your risk. Or if you want to have the luxury of living in a house or apartment that you own yourself.

But financial unicorns aim at financial freedom and not status symbols. So I will stay away from risky real estate as investment opportunity, at least from now on.

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