Diversifying your investment portfolio is essential. If you put all your eggs in one basket, you could suffer a major loss in the blink of an eye. And if you aren't investing, inflation will rob you blind. Many people tend to avoid real estate investments because they think they are scary or need a lot of money to invest. Neither is accurate and to reassure you, there are some great reasons why real estate is a good investment.
If you’re already considering an investment in real estate, you’re about to embark on one of the best investment adventures of your lifetime.
Here are the top reasons you should consider it, even if you’ve never invested in real estate before.
You Can Leverage Your Investment
There aren’t too many other investments that allow you to invest in assets worth much more than you have to invest. For example, if you have $50,000 to invest in the stock market, you can usually buy just $50,000 worth of stock.
“With real estate, you can put down a fraction of the property's cost and invest in it.”
For example, let’s say you found a property for $250,000; if you put down $50,000, chances are you could find a loan to finance the rest as long as you have good credit and stable income.
You Can Build Equity Through Loan Amortization & Appreciation
With that, it means you invest just 20% of the asset’s value and own it. Then, over time, as your tenants pay you and you pay the mortgage down, your equity in the property will increase. The combination loan amortization (pay down) and organic market appreciation work together to create equity in the property. Over time, these two factors create one of the greatest financial tools for building wealth.
You Force Appreciation
“Unlike stocks or bonds, you can force the real estate to appreciate. It sounds weird, but it’s possible.”
First, know that real estate appreciates organically. On average, real estate appreciates 3% – 5% a year without you doing anything except maintaining the property. But, you can indeed increase the rate of appreciation in real estate. In residential real estate, investors can create "sweat equity" by making renovations or repairs to a home. Commercial investors have many opportunities to boost property values through methods such as reducing operating expenses, creating additional income streams, and optimizing performance of the asset.
What's more, leverage amplifies real estate returns. When a $250,000 property appreciates by 5% to $262,500, the $12,500 yield on the $50,000 investment equates to a return on investment of 25%! This leveraged yield is what makes real estate a preferred investment vehicle for wealthy investors.
You’ll Get Tax Benefits
Like business owners, real estate investors can take advantage of a variety of tax write-offs:
• The mortgage interest and origination points paid on the loan
• Maintenance and repair expenses
• Depreciation (spread out over 27.5 years for residential or 39 years for commercial) Note: for advanced investors, there is a way to accelerate depreciation, allowing them to reduce income taxes even further.
• Real estate taxes and property insurance
• Property Management Fees
• Other operational Expenses
Always talk to your tax advisor before assuming you can write expenses off, but just know that real estate investments have many tax benefits. When you invest in stocks or bonds, you can only write off any capital losses if you sell the asset for less than you paid for it.
You Can Earn Regular Cash Flow
If you buy and hold investment real estate, you can generally earn positive cash flow. The generation of income in addition to appreciation not only increases the total return of real estate investment, but it creates an additional source of income for the investor. Creating multiple streams of income is a savvy move for any investor and many people invest in real estate to create retirement income.
You Can Experience Less Volatility
Investing in the stock market will likely leave you feeling uneasy. As 2020 showed, it can change in the blink of an eye. One minute you have a significant investment, and the next, you’ve lost 1/3 of your portfolio (Feb-Mar 2020).
When you invest in real estate long-term, you're investing in an appreciating asset that does not come with the volatility associated with wall street. Real estate, especially residential real estate is one of the most recession-resistant asset classes. This is due to the fact that no matter how bad the economy gets, we all need a place to live. Think food, water and shelter. It may go through hills and valleys, losing some value along the way, but housing usually bounces back if you hold onto it long enough.
You Can Pass Real Estate Down to Your Heirs
If you want to leave a legacy behind but don’t think going cash is a good idea, passing real estate down can be even better. Not only will you give your heirs an income-producing asset, but it’s also an appreciating asset. This way they can either keep the property and let the legacy continue or sell it for immediate cash. One great thing about passing down a property to an heir is that (at the time of this writing) the IRS allows your heirs to use the value of the property (insert inheritance threshold) at the time of transfer as the tax basis. This means that even if you’ve owned the property for 50 years and have depreciated it completely, your heirs will be able to use depreciate the same property a second time to offset their passive income.
You Can Leverage Equity to Increase Your Real Estate Portfolio
One of my favorite wealth-building techniques is to use an investment property’s equity to grow your real estate portfolio. For example, let’s assume you have a property with some equity and you are able to do a cash-out refinance and borrow an additional $50,000. You can use that $50,000 to invest in another property without selling the first. Now you will have two properties that are producing income and appreciating without any having to come up with additional capital out of pocket.
What Are the Drawbacks of Investing in Real Estate?
Like any investment vehicle, there are pros and cons to investing in real estate. Understanding the downsides can help you make sound investment decisions. You may find that you still want to invest, but knowing the negatives can help you make smarter choices and protect yourself.
There’s No Guarantee
Like any investment, there’s no guarantee that your property will appreciate or that you’ll make a profit. Many factors that determine what happens, including the state of the economy, the availability of capital (lending environment), federal reserve policies, supply and demand trends, political influences, and local circumstances are completely out of your control. Generally speaking, real estate is best suited as a long-term investment and time will heal most market corrections.
Working as a Landlord Isn't For Everyone
You have to be a specific type of person to handle being a landlord. Dealing with tenants, toilets and turnovers can be a very stressful and time-consuming job. Ask me how I know this! It takes a special set of skills to be able to market, do showings, screen applications, manage and sign leases, coordinate repairs, collect rents, process evictions, etc. Hiring a professional property management company can be a big help to those not interested in pursuing the landlord game. Unfortunately, the cost of hiring a professional manager can seriously impact or even eliminate positive cash flow in the early years of owning a home or small property. Although, with commercial properties of scale such as multifamily, the income is generally large enough to justify hiring a professional manager without significantly impacting cash flow.
Financing is Trickier
Securing financing for an owner-occupied property such as your home is typically easy if you have decent credit and a stable income. You’ll need a down payment and can usually finance the rest in the form of a fixed-rate loan.
When buying an investment property, lenders aren’t as generous with their financing options. They often have tougher requirements and more hoops for borrowers to jump through. Lenders for rentals require higher credit scores, lower debt-to-income ratios and higher down payments. For commercial properties, lenders have additional net worth and track record requirements.
Cash Flow Is Not Guaranteed
There’s no guarantee that you’ll always have tenants. If your tenant's bail is on you, the mortgage and expenses fall on your shoulders. If you do have a mortgage, you must keep paying it even though you aren’t receiving rent for the time being. This is generally less problematic in larger properties where a single vacancy can easily be absorbed. When renting out a single-family home and your tenant skips, you have no income for that property. Whether pursuing residential property (1-4 units) or commercial, you'll need to set aside a reserve fund to be able to weather any storms that may come your way.
The Bottom Line
Real estate is a great way to diversify your investment portfolio.
You can offset the higher risk of other investments, such as money invested in the stock market. In addition, if you invest in real estate, you can enjoy the cash flow while the property appreciates, giving you significant capital gains when you need it most – in retirement.
Investments into real estate are illiquid. Don’t invest money that you anticipate needing in the near future. Generally speaking, the larger the property, the more time it will take to sell.
Real estate investing is not a hobby. It requires a multitude of skills and years to master. Risks include fluctuations in market
conditions, tenant risk, legal hazards and environmental risks, to name a few.
As with all investments, a total loss of capital is possible. Past performance does not guarantee future results. The uneducated novice real estate investor takes on additional risks that may arise due to lack of experience and education.
Of course, without risk, there is no reward. And many of these risks can be mitigated.
Passive Real Estate Investing
It may seem overwhelming to buy investment real estate, find quality tenants and manage the property, but there are other options.
Passive Wealth Investors is a great resource for those who are interested in the benefits of real estate investing but do not have the time, skillset or desire to invest on their own.
Not only do we invest in real estate, but we allow qualified investors to invest with us on our deals. This allows passive investors to take advantage of all the groundwork we have laid over the last 20 years.
Passive Investors can benefit from our strategic market selection, deal sourcing, underwriting, negotiations, legal structuring, due diligence, financing, property management, asset management, etc. This is a great way for you to passively participate in a very complex investment vehicle and obtain all of the benefits that come along with real estate investing without spending the time and money required to acquire the necessary degree of sophistication.
For more information on how to invest with us, click the button below