Real estate investing is exacerbating income inequality

The Thinker by Rodin

Have you met Kevin? Kevin, i.e. Kevin Paffrath, has a YouTube channel, says he’s a millionaire and will help you get started in real estate investing so you can be a millionaire too. He’s handsome, reasonably young and looks overly caffeinated. The same is true of Graham Stephan who while being a millionaire still lives like a miser. He’s subsisting on a lot of oatmeal according to his many YouTube videos. Both are rich and made their millions buying, selling but mostly renting out their properties. And both are glad to help you do the same, as well as coach you on the secrets that made them rich too, for free if you watch only their YouTube channels but also for money if you want to attend their lectures, get their books or DVDs, and get online with them for semi-private chats.

The YouTube algorithm decided I am interested in real estate investing. I’m not interested enough to actually do what these guys are doing, but I do have a friend locally who is making most of his money through renting out rooms in houses that he owns. Maybe that’s what got me curious. This gives him time to do what he really likes: some IT consulting fixing and maintaining computers, servers and such; and coaching at the local high school which pays much less than the minimum wage.

I’m guessing though that he didn’t get all this property by chance. I’m betting he inherited a significant amount of money that let him get started in this business. I don’t know for sure because I’m too shy to ask him. But Kevin and Graham aren’t that shy, and proudly state that they made their fortune the old-fashioned and new-fashioned way. The old-fashioned way is to buy properties on borrowed money on fixed 30-year mortgages, rent them out and use the rent to maintain the properties and pay the property taxes. The new-fashioned way is to use the tax laws that make it possible for them to pay little in the way of capital gain taxes. It’s the latter that really irks me about Kevin and Graham.

Anyhow, they are happy to try to convince you to get into real estate investing too. It’s also clear from watching their videos that they are more than a little obsessed about real estate and money in general. It’s unclear if they have any time to enjoy their money and seem obsessed with acquiring more and more of it. They figure you are too so why not try to monetize their talent? And to be fair, both men don’t appear to be bamboozling anyone. They qualify themselves as just some guy on the Internet, tell you to get your own independent advice, and that making money in real estate can be profitable if you do it right, but it’s not easy.

I was watching Kevin’s recent video yesterday on why he’s not a fan of Roth IRA’s. It’s definitely a perspective I would not get from my personal financial adviser. He shows you how you could use some of the money you set aside to invest, above the amount you would lose over the years with a Roth IRA (by paying taxes on the money upfront) to buy real estate instead. And conceptually, it sounds great. When you save enough to buy one home, rent it and maintain it and ten years later use its profits to go buy another one.

But it all depends on whether you have the time and energy to commit to buying other properties, maintaining them, and being a landlord. For me, being a landlord runs about dead last on the sorts of things I would do willingly. I might sell used cars first. Basically, I’m bad at confronting nasty people. Not all tenants are bad and making sure you have the right tenant is important to keep an income stream going. But there’s bound to be some nastiness. I don’t want to deal with it. You could contract it out to someone else, but that makes it all less profitable.

Like most homeowners, I discovered that the cost of maintaining houses for over thirty years is considerable. We owned a property in Virginia for 22 years. It was bought for $192,000 in 1993, sold in 2015 for $505,000 but we also spent about $120,000 maintaining and improving it. And of course we paid lots of money in interest payments and other fees. In short, maintaining a house is not for the timid or financially challenged. If you are going to get into this game, make sure you can get cheap loans or have a whole lot of working capital.

I was so busy with my regular job that just maintaining our house was more than enough extra work, and it took 22 years to realize the gain on the property, which was transferred to buying our next property. Fortunately we own it free and clear. If you get into real estate investing, the income may appear to be “passive” but you will probably be working your ass off maintaining these properties and dealing with the hassles of investing in real estate and being a landlord.

In short, real estate investing is not for everyone, and it’s not an easy way to riches. But goodness! I’m learning from Kevin and Graham that there are some real tax advantages to it. And that part had me seeing red. It’s not that I can fault Kevin and Graham for getting these perks, but essentially they delay forever paying taxes on all the appreciation of their properties. Moreover, they can effectively escape ever paying taxes on these gains if you never sell them or don’t use the sale to buy something else. You can, for example, bequeath your properties to your posterity, and they can keep this scheme going indefinitely too.

This is in fact how Donald Trump has made his wealth. It’s why he says he loves debt. Rest assured he is deeply indebted, but if he can sell one property purchased largely with borrowed money and buy another one with the proceeds, he can pocket a lot of cash while deferring gains on them too. This is one of the reasons Trump is pulling all stops to keep his tax returns from getting released. If people discover he pays little to no taxes while they do, they are going to be furious.

When Elizabeth Warren talks about a wealth tax, this is exactly the sort of wealth I want to see taxed. You should too. These are all legal schemes, but they drive wealth inequality, exacerbate deficits and in general keep the government from having the revenue it needs to give us a first-class society.

I’m betting Kevin and Graham would grumble a little, but they definitely owe the rest of us a heap of money in the form of higher taxes. Mostly, we need to tax their capital and property gains. We should not feel the least bit guilty to go after it.

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