Discover 5 Reasons Why Real Estate is the Ideal Investment
Are you taking advantage of these five benefits?
By Mike Jacobson
A few years ago when my wife and I were on our way home from a vacation, We checked the stock on our way home and it had dropped from $60 per share to $35. That was probably the worst re-entry we ever had following a vacation. The stock in the company my wife worked for lost almost half of its value in one week. And her 401(k) was heavily invested in it.
Have you ever had a stock investment that kept going up, and then one week it dropped like a roller coaster? Were you concerned that losses would erase all of your gains and some of your principal?
Are you concerned about looming inflation with all the stimulus money pumped into the economy? Do you wish there was a way to shelter more of your income from taxes?
If you answered “yes” to at least one of the questions above then read on and learn why real estate has been the vehicle of choice by many for building wealth.
REAL ESTATE, A PROVEN CHOICE FOR WEALTH BUILDING
Real estate has five powerful features that make it a great investment. And how do you take advantage of those features to maximize your returns?
Here’s a quick look at what those features are.
The first letters spell the word I.D.E.A.L. Learn about each of these and see why real estate is an “Ideal” investment.
Income is the first feature typically sought from a property held for investment. The property should produce regular, reliable income. This is the net income, after expenses such as taxes, insurance, management, utilities and repairs. It should also be enough to cover the mortgage. Note that income is taxed at ordinary income tax rates.
Net income can be increased by making improvements that make the property more attractive. Expenses can be reduced with effective property management and preventive maintenance.
Net Income also increases over time with inflation. As market rents go up the net income will follow. Although taxes and maintenance costs increase with inflation, the principal and interest paid on the mortgage typically remain constant. So the increases in net income can outpace inflation.
Some stocks are income-producing and distribute dividends, but they do not enjoy the next benefit, depreciation.
Depreciation is a tax reduction strategy. The IRS requires owners of investment properties to account for the deterioration or wear and tear on the buildings each year. This is called depreciation.
Although real estate increases in value, the IRS permits us to write off the cost of improvements over time, reducing our taxable income. Since taxes are the second greatest threat to your wealth it pays to know how to use the tax code to your advantage.
Depreciation can be used to offset income from the property and, in some cases, other income as well. It is not uncommon for depreciation to offset the taxable income.
Again, traditional stock and bond and mutual fund investing cannot take advantage of this tax benefit.
Equity is the market value of the property less any mortgages and liens. It may be obtained by buying at a discount or created over time as inflation increases the value of the property. Equity can also be created by taking a “junker” house and improving it to a “jewel” for rental or sale.
The market value for single family homes is driven by comparable sales in the neighborhood, but for commercial properties it is driven by the net income the property produces. So a significant amount of equity can be created in a commercial property by improving its appearance, appeal, occupancy and rent in addition to reducing expenses.
We have little or no control over the “equity” in our traditional investments, except to buy or sell them. With real estate we do have a level of control over the growth of our equity.
Unlike stocks, the gain from real estate can be rolled into another property and the tax liability deferred. This is like trading houses for a hotel in Monopoly.
Amortization increases the equity in the property every time a loan payment is made. As the tenants pay rent and we make payments on the loan we are reducing the mortgage balance, month after month. This is called amortization.
Real estate provides this additional benefit not present with gold, or stocks, or bonds or many other traditional investment vehicles.
Leverage is the feature that makes real estate a very powerful investment. You don’t need $100,000 cash to buy a $100,000 investment. A good house can typically be purchased with a conventional loan for 20-30 percent down. Using creative financing techniques this can be done for less, but we’ll stick with the conventional down payment as an example. This enables you to enjoy the gains of a $100,000 asset with only $25,000 of your own funds invested.
So, if the $100,000 asset increases in value to $125,000, this would be a 25% increase without leverage. But, if we only put down $25,000, then this would be a 100% return on investment. See the power of leverage?
These five attributes can be combined to make a particular investment better. And while you may be able to maximize some attributes, it is not usually possible to maximize all attributes in a given investment. It is the sum of these attributes that creates our total return.
Since that vacation a few years ago we have chosen to diversify our portfolio further, selling some stock and purchasing additional real estate.
If you would like to learn more about making your investments more I.D.E.A.L. so you can maximize the total return then join our Attune Club where more information and resources are available to you. Join the club here.
Mike is a retired aerospace engineer with a passion for real estate investing and teaching financial literacy. He lives with his wife in Daytona Beach, Florida.