I think we all recognize the positive financial outcome that is possible through investing in real estate. Whether you invest in real estate passively, have one or two rental properties, or its a full time job, there is no doubt that Real Estate is an important key to achieving financial freedom in your life.
Here are 6 of the best reasons why many people today and throughout history consider real estate to be the premier investment around:
Cash flow
It is important to note we are focusing on the benefits of income producing real estate properties rather than single family homes that are being occupied by the owner.
When you invest in real estate, you are not only building equity through the appreciation of the property, but at the same time you are getting a constant cash flow from the collection of rent.
Cash flow is the profit you rake in each month after collecting your rent and subtracting all your operating expenses, while tucking away some cash for any future repairs or maintenance of your property. Cash flow becomes even more important if one of your main objectives is to enjoy your life through the passive income your properties produce.
Most of the time this cash flow is protected from taxes because of the enormous tax benefits of real estate, such as depreciation. Also the cash flow from commercial real estate has historically been better than dividends from stocks and bonds.
Low Volatility
Real estate is considered an illiquid asset, meaning that you can’t sell your position quickly as you can with stocks. Although often cited as a negative thing, in times of stock market volatility, real estate’s illiquidity shields it from the emotional overselling and undervaluation that can occur with stocks.
Tax Benefits
Real estate also provides several tax benefits that are unique to it. Tax deductions such as depreciation, interest payments and other expenses can shield income produced by real estate. Furthermore, any appreciation gains from the sale of property is taxed at long-term capital gain rates, which are usually lower than individual tax rates.
Let’s look at an example. Let’s say you purchase a building for $1,000,000, $250,000 of which is for the land (Land can’t be depreciated). So the basis for the depreciation is $750,000. After 5 years, $136,000 can be depreciated. This depreciation can be used to offset taxes from the income generated from the property.
However, investors have to keep in mind that upon sale of the property any amount depreciated will be recaptured by lowering the basis. What does this mean? Let’s look at an example:
Purchase price of property: $1,000,000
Depreciation deductions claimed in five years: $5,000 per year
Sale price in the 6th year: $1,150,000
Depreciation recapture tax rate: 25%
Capital gain tax rate: 20%
The adjusted cost basis will still be $975,000.
The gain from the sale is $1,150,000 – $975,000 = $175,000.
Let’s break down the taxes that are paid.
Depreciation recapture tax: $6,250 ($25,000 x 25%)
Capital gains tax: $30,000 ($150,000 x 20%)
However if the investors roll over the gains from the sale of the property into the purchase of another property through a 1031 exchange, then taxes can continue to be deferred.
Hedge Against Inflation
Inflation can be defined as the standard rise in the price of goods and services over time, resulting in a reduction of the purchasing power of our dollars. When investing, inflation is a valuable statistic when considering potential returns. If the return of your investment isn’t outperforming inflation, then you are essentially losing money in the long run, even though it may seem that the value of your investment is going up.
Real estate is a great hedge against inflation. The returns you receive from a real estate investment come rental income and capital appreciation of the property. These two sources of returns are great combatants to inflation and add the risk mitigation you may not receive from other investments such as stocks. Historically speaking, returns on commercial real estate have outpaced inflation nicely, since home values and rents typically increase during times of inflation.
Leverage
Another major benefit of real estate investing is the ability to use low cost debt to increase your purchase power. This is called leverage. Leverage can exponentially increase the total returns of the property. Let’s look at an example of leverage at work.
With Leverage
Purchase price of property: $1,000,000
Down payment (25%): $250,000
Sale price: $1,250,000
Return on investment: 100% (your return on the $250,000 you placed as down payment is $250,000)
Without Leverage
Purchase price of property: $1,000,000
Down payment (100%): $1,000,000
Sale price: $1,250,000
Return on investment: 25%% (your return on the $1,000,000 you put down for the purchase is $250,000)
Leverage frees up your cash to invest in multiple properties. For the above example you can spread your $1,000,000 in the purchase of 4 properties (with 25% down payment on each) as opposed to the purchase of one property with no leverage.
Hard Asset
Real estate is a hard asset.
Hard assets have a tendency to retain their value, especially when looking at real estate. No matter the state of our economy or currency, real estate will always hold some intrinsic value, due to its tangibility and use. Hard assets are also valuable because they have a limited supply.
Lastly, an investor actually owns an asset that they can see and feel. It is something that they can point out and say “I own that!”, which is always a great feeling.
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