Note From Kalen: Today we have an awesome guest post by Brent. As with any investing decisions, do your own research and only invest in what you understand. This is one person’s opinion on real estate. I also favor real estate investing, but not everyone has the same needs. Do your own homework. Enjoy!
Real estate has been touted by many as a “great investment.”
You hear it all the time….they say “if someone really wants to grow their wealth, then invest in real estate.”
But why do so many people think that real estate is a good place to invest?
What are the advantages of real estate that make people choose it over other investments?
In this article, we will break it down for you into 7 items that makes real estate an attractive investment. Then you can decide for yourself!
This may be the most attractive reason to invest in real estate, at least to some. Everyone wants to increase their cash flow and be able to do it with minimal work each month. Real estate allows you to do that. When you buy real estate, the majority of work will be preparing the property for your tenants to live in, whether that is making upgrades, doing maintenance, or cleaning when someone moves out. And if your income is high enough, these are all things that can be hired out to a third party. In fact, property management firms will take care of everything(for a fee of course) so you don’t have to be involved at all, except for interacting with the property management firm of course.
If you weren’t aware that real estate has tax benefits, then you need to read this. Real estate is one of the more tax advantaged investments one can make. Why is that? This is because of an expense that the IRS allows someone to deduct from their rental income called depreciation. On its face, depreciation sounds like a bad thing, but trust us, it’s not.
So how does it work? When you buy a property, that property has a certain value or worth(hopefully more than what you paid). Each year, the IRS allows property owners to deduct a certain amount of the property’s value and subtract it from their rental revenue. Why do they allow this? This expense is supposed to allow for the wear and tear from the property becoming older. For residential rental properties, a property is generally depreciated on a 27.5 year straight line schedule. By subtracting depreciation from rental income, your essentially taking an expense that didn’t cost you anything, and using it to limit the income you report to the IRS, thus lessening or even removing your tax liability each year.
So what is the catch? The catch is when you sell the property, any depreciation that was used, will need to be recaptured, assuming you sell the property for more than the original value minus depreciation that was used. Recaptured depreciation means that all of those taxes you avoided, will need to be paid when you sell the property.
Price Appreciation/Inflation Hedge
Any time you own a physical asset like a house or an apartment, it creates the potential for price appreciation as inflation occurs over time. That price appreciation not only protects against inflation eroding away your investment, but it also helps build equity in the property. But buyer beware that the opposite can also be true…that your property may depreciate in value for a variety of reasons creating negative or decreased equity.
Inflation isn’t the only thing that can cause price appreciation. If you buy your property at the right price, you can potentially have instant price appreciation. Or if you buy a property in the right location, you may see it slowly appreciate as real estate values in the surrounding area also increase. This is always something to shoot for as increasing property values often go hand in hand with increasing rental rates…a win win!
Each month, you will receive your rent check from your tenants and use that to pay the mortgage as well as other expenses associated with owning a rental property. Over time, as you pay the mortgage, a portion of the payment will go towards paying interest and a portion will go towards paying back the loan, which is called principal. This principal doesn’t immediately go into your pocket, but it does go towards building equity in the property and ultimately improving your net worth.
So don’t forget that cash flow is not the only thing that will increase your net worth while owning the property. Principal payments will also.
Attractive Rates of Return
When a person buys real estate, they get to create their own goal for rates of return. Many investors won’t buy a property without expecting to receive a rate of return they are happy with. If an investor finds the right deal, it isn’t uncommon to expect 20 percent annualized rates of return from real estate investing. On a more modest level, the 10 percent threshold is very common. When compared with other investments such as the stock market, real estate can generate an equal or better return over the long term.
There are a couple reasons that real estate has potential for outsized rates of return. First, there is greater liquidity risk than certain other investments. This risk must be compensated for and this typically happens naturally as the competition to purchase a house is not the same as the competition to purchase a stock on an exchange. Therefore there is greater room for negotiation/bargaining between buyer and seller.
Second, knowledge of a real estate market is localized. A person can specialize in a geographical area, whether that be large or small, and create a string of predictable successes using proprietary knowledge of the market based on investing experience.
And of course don’t forget about the tax advantages that we’ve already discussed above.
When talking about rates of return, you need a consistent way of projecting and measuring them. To help measure your rates of return, we recommend this rental property calculator from IQ Wealth Calculators.
You Are In Control
Unlike other investments, owning real estate puts the individual investor in control. With the stock market, a person is at the mercy of decisions being made in a boardroom where they’ve never been, by people they’ve never met, regarding things they know very little about.
With real estate, you are in control of how much you want to invest, the property you want to buy, the price you want to pay, the tenants you want to rent to, the rate of return you want to have and the upgrades you want to make. You are almost in control of everything. The market will influence the purchase price and rental rates, but besides that, you are in control of your investment.
A Tangible Asset
When you own real estate, you own a tangible asset. Real estate is NOT something you can only look at via your computer screen or a once monthly statement. This is something you can actually touch. This sort of goes hand in hand with you being in control and it’s something many value relative to other common investments such as stocks or bonds.
To add real estate to your investment portfolio, creates diversification in more ways than just adding a new asset class. It adds a physical asset where you currently may be lacking in that department.
As we’ve said before, real estate is commonly mentioned among investors as a great place to invest. And depending on your opinion of the 7 items mentioned above, you may agree. But regardless of your investing style, real estate is certainly worth consideration when it comes to your investment portfolio.
About the Author:
Written by Brent from IQ Wealth Calculators.