Why Real Estate Investing Makes (Dollars and) Sense

If you go on Youtube or scroll through Facebook, and chances are you’ll see at least one advertisement for a group or “guru” who 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, we’ll examine the tried-and-true tactics that can increase your revenue, pay off debt, and even fund your retirement!

WHY INVEST IN REAL ESTATE?

One of the basic principles of real estate investment is that 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 most considerable expense.1

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

1. Appreciation

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

The S&P CoreLogic Case-Shiller National Home Price Index, which tracks US residential real estate prices, released its latest results on August 29 with the headline “National Home Price Index Rises Again to All-Time High.” 2

Source: ZeroHedge3

While no investment is without risk, real estate has proven again and again to be a solid choice to invest your money over the long term.

2. Hedge Against Inflation

Inflation is the rate at which the general cost of goods and services rises. As inflation rises, prices go up. When you have money sitting in your bank account, it loses its value 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 grow with (or often exceed) the inflation rate. Therefore, real estate is a smart place to put your money to guard against inflation.

3. Cash Flow

One of the significant benefits of investing in real estate over the stock market is its ability to provide a relatively 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 significant enough to leave you a little extra cash each month, as well. You could use that extra money to pay off the mortgage faster, cover your 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 until you own the property free and clear, leaving 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. The increase in value can be a great way to have money for retirement or even fund a child’s college education. 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 10% down ($10,000) and borrow the remaining $90,000 in the form of a mortgage.

Even though you’ve only invested $10,000 at this point, you can 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 $90,000 (plus interest), and you get to keep the $20,000 profit.

That means you made $20,000 off of a $10,000 investment, nearly 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. The deductions include interest paid on the mortgage, maintenance, repairs, and improvements, but it also has something called depreciation.

Depreciation is the theoretical loss your property suffers each year due to aging. While it’s true that as home ages, it will structurally need repairs and systems will eventually need to be replaced, we’ve also learned in this post that the value of real estate appreciates over time. Getting to claim a “loss” on your investment that is gaining importance 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, as well. Generally, when you own an investment property, you pay a capital gains tax on any profits you make when you sell the property.

However, when you sell your principal residence, you are exempt from paying taxes on capital gains (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 you remodel it, and then sell it for a tax-free profit two years later.

Section 1031 Exchanges

Besides profiting off your personal residence tax-free, it is possible to sell an investment property tax-free if you do it through a 1031 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 (i.e., stocks, bonds, mutual funds, etc.) through an Individual Retirement Account (IRA) or 401(k). In actuality, the IRS allows individuals to invest in retirement funds in real estate and other alternative types of investments. By purchasing your investment property through an IRA, you can take advantage of all 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, you can largely shield the tax liability on the profits you earn on your real estate investment.

TYPES OF REAL ESTATE INVESTMENTS

While there are numerous ways to invest in real estate, we’re going to focus on three primary ways average investors earn money through real estate. We 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 look easy. Commonly referred to as a “Fix and Flip,” investors purchase a property intending to remodel it in a short period, with the hope of selling it quickly for a profit.

Remodel and resell is a higher-risk tactic and one for which many of the real estate “gurus” we talked about earlier claim to have the magic formula. They promise huge profits in a short amount of time. Investors need to understand the risks involved and prepare 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 and 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 while taking 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 for first-time investors to get started.

And according to the US Bureau of Labor Statistics, rents for primary residences have increased 21.9 percent between 2007 and 2015 as demand for rental units continues to grow.1

3. Short-term Rental

With the massive 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 is also an increasing 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. However, the most beneficial properties are near popular tourist destinations. You’ll need an experienced real estate professional to help you identify the right property if you want to succeed in this highly competitive market.

DOES REAL ESTATE INVESTING SOUND TOO GOOD TO BE TRUE?

We’ve all heard stories or 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 increased 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, as long as you have a trusted team in place to complete the remodel quickly and within budget and 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 ups and downs without stress because you know your property value is bound to increase over time, and your rental income covers your expenses.

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

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

Sources:

1. Bureau of Labor Statistics Consumer Expenditure Survey Annual Report

– https://www.bls.gov/opub/reports/consumer-expenditures/2018/home.htm