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Gen X, Y investors see fiscal hopes sink in real estate quagmire

CNBC Digital presents the second in a series of five articles by members of its Financial Advisor Council on worst-case financial scenarios affecting clients in four age brackets: millennials and younger Gen Xers; people in their 40s and 50s; 60-somethings and pre-retirees; and those already in retirement. This week's guest contributor is Tim Maurer, director of personal finance at the BAM Alliance.

Throughout the course of my career, I've heard a lot of financial horror stories. The majority of these stories are told by baby boomers whose aggressive stock market strategies went bust, often at the behest of a transaction-oriented "advisor."

The most pain—yes, even marginally greater than that of former Enron employees and Bernie Madoff scam victims—has been felt by a younger generation, however, in America's suburbs, far from Wall Street.

Peter Gridley | Photographer's Choice | Getty Images

Relinquishing its collective Abercrombie & Fitch flannel shirts for suits and ties, Generation X was buying its first homes just as the Farrelly brothers—directors of "There's Something About Mary"—were hitting the movie scene and the real estate market was warming up.

These initial purchases were greeted with solid gains and falling interest rates, so when Scott and Ann—as we'll call them—were ready to move up from their starter home to make room for their growing family, they decided to refinance and rent their first home. They got good renters, made a monthly profit and saw their net worth begin a sharp upward climb.

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Since it worked so well the first time, why not do it again? Scott and Ann took meaningful chunks of their ever-expanding equity from their growing real estate portfolio to fund new home purchases. After all, the banks wouldn't lend them this money if they actually thought it was dangerous, would they? In their early 30s, Scott and Ann were poised to become millionaires soon, at least on paper.

This strategy worked great—until it didn't.

They lost a renter in one house and started having less amiable phone calls with lenders, soon resorting to unsecured credit cards for excess expenses. Their equity shrunk, seemingly overnight, and kept shrinking until it ceased to exist. Adjustable mortgage rates started adjusting in unfavorable directions, while their net worth accelerated into the red.

"Generations X and now Y are more conservative than their predecessors, which is completely understandable after they saw the financial crash of 2008 follow the real estate crash of 2006."

Scott and Ann's household income—more than $150,000 annually but comingled with their real estate "business"—could no longer support their family, until all was eventually lost in a dual personal bankruptcy that shattered them personally and threatened them professionally.

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Plagued by guilt and embarrassment, Scott, who'd shielded Ann from most of their financial woes until they were impossible to hide, had trouble sleeping through the night, until he woke one morning with a freeing picture in his mind.

He saw the number zero preceded by a dollar sign. "$0," he told me, "is the amount of money and material possessions we take with us when we leave this world." His vision provided a valuable lesson, indeed, but one I'd have preferred Scott to learn in a book.

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Scott and Ann's story is 100 percent true, but sadly it's not unique. The intense compounding of leverage-fueled rates of return on seemingly safe hard assets wooed entirely too many Gen Xers into part-time landlord gigs that eventually failed. For many more, home equity dwindled, thanks to cars, vacations and even more noble uses, landing vast numbers of 30-somethings among the millions still underwater on their homesteads.

As a generation, however, we've learned several lessons that will serve us well into the future:
Real estate can be a good investment, but it is not a safe investment, made even less safe because it is typically bought with leverage.
Without leverage, the most you can lose is your initial investment. With leverage, you can lose substantially more than your initial investment.
In order to benefit from rental real estate, you must be willing and able to be a landlord. Most aren't.
Owning more of a good thing is not always better. Concentrating is gambling; diversifying is investing.

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Studies have shown that Generations X and now Y are more conservative than their predecessors, which is completely understandable after they saw the financial crash of 2008 follow the real estate crash of 2006, which has been preceded by the tech bubble bursting in the early 2000s.

Some say younger generations are being too conservative, but I think it's a good lesson to learn: No investment is likely to make us, and therefore it shouldn't be put in a position to break us.

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