Real estate is a great investment vehicle. Often, real estate investments outperform stocks, bank CDs, bonds, gold, and many other investment alternatives. Please read on to find out why.
Leverage is a powerful wealth building tool when used correctly. Let’s compare purchasing stocks to purchasing real estate to highlight the power of leverage. If you are faced with the decision of how to invest $100,000, how much buying power do you have? Put another way, how many dollars worth of stock can you buy versus property? The answer is you can only buy $100,000 worth of stock however, you can buy $1,000,000 worth of property when leverage is utilized. Assuming a 10% appreciation in both markets (stock & property) let’s look at realized returns. In the stock market, your $100,000 increases to $110,000 and you realize a 10% gain. Conversely, the same 10% appreciation increases the value of your $1,000,000 property Abdo Romeo to $1,100,000. The realized gain is $100,000 and since your initial investment was $100,000, you’ve doubled your money. You realized a 100% gain.
When you buy $100,000 worth of stock, what is the value of your portfolio the day you buy it? It is $100,000. This is not that case with real estate. The price of a property can vary tremendously making it possible for an investor to over pay or under pay for an asset. The $1,000,000 property purchased with a $100,000 down payment may only be worth $825,000 if the investor overpaid for the property. Alternatively, it may be worth $1,500,000 if the investor purchased the property from a distressed seller and negotiated a strong transaction. My students always pay 40, 50 or 60 cents on the dollar for properties they acquire thereby giving them instant equity.
Another positive to investing in real estate is the fact that the tenants pay off the mortgage. Assuming the purchase was made correctly, the tenant’s rent payments are paying off the mortgage while you are enjoying monthly positive cash flow after all expenses are paid. Typically, the rents are being increased year over year and your mortgage expense remains constant, therefore after annual rent increases your positive cash flow increases. At the same time, the equity in the property is increasing as every month passes due to the amortization of the mortgage and the appreciation of the property. The market appreciation is driven by local influences. In some parts of the country, appreciation rates are negative and in others they are positive. I encourage my students to invest in areas where the economy is improving, jobs are being created and the values are on an upward trend.
Additionally, there are plenty of tax advantages to owning income producing properties. Depreciation and tax write offs make real estate investing very attractive. Please consult with your tax advisor for details on all of the advantages applicable to your specific circumstances.
When you buy stock in a company, there is nothing that you, the individual stock holder, can do that will increase the value of the stock. This is not the case when it comes to real estate. Value is added to properties every day all over the country when someone takes a rundown property and updates the property, removes functional obsolescence, adds additional living space, adds a garage, etc. A large majority of the properties I have purchased over the years have been physically distressed. I have created enormous added value by redeveloping these properties and thereby creating tremendous equity in my portfolio. Not all property issues are related to the physical condition of the building. In the example from the second paragraph, a savvy investor can buy a $1,000,000 property with a rent roll that is below market rate. Within the first year, this investor can systematically raise rents and decrease expenses achieving an increase in the value of the property. This increase in value can be accomplished without having to rely on market appreciation or renovations. This type of value play is common and simply addresses an existing management problem.
Another fabulous advantage is the ability to access your equity in the form of a refinance. You can “pull money out” of a property by refinancing with a bank and then use this money to continue acquiring more revenue producing assets in your portfolio. The best part is this money is not taxable at the time you do the refinance. One word of caution here: Make sure that you do not over leverage your portfolio and create a house of cards that will tumble if you experience a tightening in the market.
If the world of landlording or the day-to-day dealings of being a hands-on real estate investor sounds scary, the good news is there are still ways to put your money to work for you by being a real estate investor. You can invest in real estate as a private lender in a specific real estate transaction by partnering with another hands-on investor. For those interested in this approach, I have several articles and videos posted on my blog explaining this option in more detail.