Why Real Estate Investing Makes (Dollars and) Sense

Why Real Estate Investing Makes (Dollars and) Sense

Turn on the television or scroll through Facebook, and chances are you’ll see at least one advertisement that promises to teach you how to “get rich quick” through real estate investing. The truth is, much of what they’re selling are high-risk tactics that aren’t a good fit for the average investor. However, there is a way to make steady, predictable, low-risk income through real estate investing. In this blog post, I’ll examine the tried-and-true tactics you can use to increase your income, pay off debt, even fund your retirement!

Why Real Estate Investing?

One of the basic principles of real estate investment lies in this fact: everyone needs a place to live. And according to the Bureau of Labor Statistics’ most recent Consumer Expenditures Survey, housing is typically an American’s largest expense.

But there are other reasons why real estate is a great investment choice, and I’ve outlined the top five below:

1. Appreciation

Appreciation is the increase in your property’s value over time. History has proven that over an extended period of time, the value of real estate continues to rise. That doesn’t mean recessions won’t occur. The real estate market is cyclical, and market ups and downs are natural. In fact, the U.S. housing market took a sharp downturn in 2008. Many properties took several years or longer to recover their value. However, in the vast majority of markets, the value of real estate does grow over the long term.

The S&P CoreLogic Case-Shiller National Home Price Index, which tracks U.S. residential real estate prices, released its latest results on August 29 with the headline “National Home Price Index Rises Again to All Time High.”

 
US Home Prices Rise Above July 2006 Levels, Hit New Record High
Source: www.zerohedge.com
 

While no investment is without risk, real estate has proven again and again to be a solid, long-term investment choice.

2. Hedge Against Inflation

Inflation is the rate at which the general cost of goods and services rises. As inflation rises, prices go up. This means the money you have in your bank account is essentially worth less because your purchasing power has decreased.

Luckily, real estate prices also rise when inflation increases. That means any money you have invested in real estate will rise with (or often exceed) the rate of inflation. Therefore, real estate is a smart place to put your money to guard against inflation.

3. Cash Flow

One of the big benefits of investing in real estate over the stock market is its ability to provide a fairly steady and predictable monthly cash flow. That is, if you choose to rent out your investment property to a tenant, you can expect to receive a rent payment each month.

If you’ve invested wisely, the rent payment should cover the debt obligation you may have on the property (i.e., mortgage), as well as any repairs and maintenance that are needed. Ideally, the monthly rental income would be great enough to leave you a little extra cash each month. You could use that extra money to pay off the mortgage faster, cover your own household expenses, or save for another investment property.

Even if you only take in enough rent to cover your expenses, a rental property purchase will pay for itself over time. As you pay down the mortgage every month with your rental income, your equity will continue to increase. When you pay off that mortgage,  you own the property free and clear. This leaves you with residual cash flow for years to come.

As the owner, you will also benefit from the property’s appreciation when it comes time to sell. This can be a great way to save for retirement or even fund a child’s college education. Purchase a property when the child is young. With a little discipline, it can be paid off by the time they are ready to go to college. You can sell it for a lump sum, or use the monthly income to pay their tuition and expenses.

4. Leverage

One of the unique features that sets real estate apart from other asset classes is the ability to leverage your investment. Leverage is the use of borrowed capital to increase the potential return of an investment.

For example, if you purchase an investment property for $100,000, you might put 20% down ($20,000) and borrow the remaining $80,000 in the form of a mortgage.

Even though you’ve only invested $20,000 at this point, you have the ability to earn a profit on the entire $100,000 investment. So, if the property appreciates to $120,000 – a 20% increase over the purchase price – you still only have to pay the bank back the original $80,000 (plus interest).

That means you made $20,000 off of a $20,000 investment, essentially doubling your money, even though the market only went up by 20%! That’s the power of leverage.

5. Tax Advantages

One of the top reasons to invest in real estate is the tax benefit. There are numerous ways a real estate investment can save you money each year on taxes:

Depreciation

When you record your income from a rental property on your annual tax return, you get to deduct any expenses associated with the investment. This includes interest paid on the mortgage, maintenance, repairs and improvements, but it also includes something called depreciation.

Depreciation is the theoretical loss your property suffers each year due to aging. While it’s true that as a home ages it will structurally need repairs, and systems will eventually need to be replaced, you’ve also learned in this post that the value of real estate appreciates over time. So, getting to claim a loss on your investment that is actually gaining in value makes real estate an appealing investment choice.

Serial Home Selling

Even if you’re not interested in owning a rental property, other types of real estate investments offer tax advantages also. Generally, when you sell an investment property you pay a capital gains tax on any profits you make.

However, when you sell your principal residence, you have an exemption from paying taxes on some capital gains. Current tax law allows a tax-free gain of up to $250,000 for singles and $500,000 for couples. The Internal Revenue Service (IRS) only requires that you live in the house for two of the previous five years. That means you can purchase an investment property, live in it while remodeling, and sell it for a tax-free profit two years later. This can be a great way to get started in real estate investing.

Section 1031 Exchanges

In addition to profiting off of your personal residence tax free, it is also possible to sell an investment property tax deferred. You do this through a 1031, or Starker, Exchange. If structured properly, the IRS Tax Code enables an investor to sell a property and reinvest the proceeds in a new property while deferring all capital gains taxes.

Tax-Deferred Retirement Account

It’s a common misconception that you can only purchase financial instruments (stocks, bonds, mutual funds, etc.) through an Individual Retirement Account (IRA) or 401(k). In actuality, the IRS allows individuals to invest retirement funds in real estate and other alternative types of investments, as well. By purchasing your investment property through an IRA, you can take advantage of the tax savings these accounts offer.

Be sure to consult a tax professional regarding all tax matters related to your real estate investments. If structured correctly, the profits you earn on your real estate investments can be largely shielded from tax liability. Just another reason to choose real estate as your preferred investment vehicle.

Types of Real Estate Investments

While there are numerous ways to invest, I’m focusing on three primary ones you can use to earn money. I touched on several of these already in the previous section.

1. Remodel and Resell

HGTV has countless reality shows featuring property flippers who make this investment strategy, the “Fix and Flip,” look easy. Investors purchase a property that they hope to remodel in a short period of time. They then sell it quickly for a profit.

This is a higher-risk tactic, and one for which many real estate “gurus” claim to have the magic formula. They promise huge profits in a short amount of time. But investors need to understand the risks involved, and be prepared financially to cover additional expenses that may arise.

Luckily, an experienced real estate agent can help you identify properties that may be good candidates for this type of investment strategy. They will help you avoid some of the pitfalls that could derail your plans.

2. Traditional Rental

One of the more conservative choices for investing in real estate is to purchase a rental property. The appeal of a rental property is that you can generate cash flow to cover the expenses. You can also take advantage of the property’s long-term appreciation in value, and the tax benefits of investing in real estate. It’s a win-win, and a great way to start if you are a first-time investor.

According to the U.S. Bureau of Labor Statistics, rents for primary residences increased 21.9 percent between 2007 and 2015.

3. Short-term Rental

With the huge movement toward a sharing economy, platforms that facilitate short-term rentals, like Airbnb and HomeAway, are booming. Their popularity has spurred a growing trend toward dual-purpose vacation homes, which owners use themselves part of the year, and rent out the remainder of the time. There are also a growing number of investors purchasing single-family homes for the sole purpose of leasing them on these sites.

Short-term rentals offer several benefits over traditional rentals, which many investors find attractive, including flexibility and higher profit margins. There is risk though, and some cities and homeowner’s associations have limits on short-term rentals. You also want to make sure you buy properties near popular tourist destinations. You’ll need an experienced real estate professional to help you identify the right property if you want to be successful in this highly-competitive market.

Does Real Estate Investing Sound Too Good to Be True?

We’ve all heard stories, or maybe even know someone, who struck it rich with a well-timed real estate purchase. However, just like any investment strategy, a high potential for earnings often goes hand-in-hand with an increase in risk. Still, there’s substantial evidence that a well-executed real estate investment can be one of the best choices for your money.

Purchasing a home to remodel and resell can be highly profitable. But you must have a trusted team in place to complete the remodel quickly and within budget. You also need the financial means to carry the property for a few extra months if delays occur.

Or, if you buy a house for appreciation and cash flow, you can ride through the market’s ups and downs without stress. This is because you know your property value will increase over time, and you have covered your expenses with your rental income.

In either scenario, make sure you’re working with a real estate agent who has knowledge of the investment market and can guide you through the process. While no investment is without risk,  you can supplement your income and set you up for future financial security with a conservative and well-planned investment in real estate.

If you are considering an investment in real estate, please contact me to set up a free consultation. I have experience working with all types of investors and can help you determine the best strategy to meet your investment goals.

Leave a Reply

Your email address will not be published. Required fields are marked *