(This advanced blog summarizes real estate investing tips and insights Lofty AI has acquired from working with thousands of investors and institutional funds.)
What are the advantages of real estate investing?
The advantages of real estate investing are truly endless. Whether you are just investing in real estate as a side job, or becoming a full-time real estate investor, there are benefits for everyone.
It is important to note the reasons why investing in real estate is different from other types of investments.
All it takes is one rental property to establish your real estate business and you will have yourself a reliable source of constant income. It should be known that the benefits of investing in real estate are only limited by your own potential. You can have as many properties as your time and energy will allow.
Unlike stocks, your real estate investments will typically not be as limited by what is happening in the economy. It also takes less skill to master the ins and outs of real estate investing than it does the stock market.
Real estate benefits are not always as apparent as many would assume. Sometimes the best benefits are those that are particular to your property. Some of the numerous benefits with well-chosen assets include:
A strong, predictable, and continuous cash flow.
A high appreciation and excellent returns on your investment.
Many tax breaks and deductions.
A chance to diversity your portfolio, leading to its lower volatility.
Leverage, which can be used to continue building wealth and create more investments.
A large hedge against inflation, creating an increase in profit.
These benefits and more will make it worthwhile for you to start learning about real estate investment. This post will dive deeper into these 6 main benefits of real estate investing.
Let's get started.
1. Cash flow
When you hear real estate investors use the phrase “mailbox money,” they are referring to cash flow.
Cash flow is income generated when your rental returns exceed your monthly expenses.
When you are generating cash flow, you are generating passive income, or essentially a profit from your investment.
When you are generating passive income, you can sit back, relax, and collect your profits every month. Your cash flow could also take care of the mortgage on the property you have bought, so essentially your tenants are covering your mortgage and your cash flow can be used elsewhere.
In many cases, cash flow only strengthens over time as you pay down your mortgage—and build up your equity, which directly correlates to the increase in rent price over time.
With a good property location, you could be earning significant income to cover your expenses, and then make you extra money on the side. A good place to start when looking for a property are urban cities with colleges and universities. These places tend to generate higher income because the demand is always there for housing.
Essentially, you want to keep increasing your cash flow, by investing in the right properties, that are in areas where a constant stream of people are moving in.
If chosen wisely, you can secure a steady flow of income for a long time and even save for retirement. It does not get much better than that!
Appreciation is often overlooked by investors, where it takes a back-seat to cash flow.
That is because it is really easy to build a discounted cash flow model, but it is extremely difficult to predict appreciation.
Appreciation is simply the increase in a property's value over time.
Real estate values tend to increase over time, which allows you to turn a profit once you eventually sell your property. In other words, your property’s value will be worth way more 30 years from now, hence why investors are in it for the long run.
If you are able to predict which areas will see the most future appreciation, or gentrification, you can easily double your money in 2-3 years. Similar to appreciation, gentrification is the is a process of changing the character of a neighborhood through the influx of more affluent residents and businesses. With gentrification, comes appreciation.
Take areas like Williamsburg in NY, The Arts District in LA, and Columbia Heights in Washington D.C.
Had you invested in these areas before they began to appreciate and gentrify, you would have made 2 times your money in just a few short years. Finding the sweet spot before gentrification is the most important time to buy a property.
If you are interested in selling your property, it should be done when the appreciation is at an all time high, to generate the maximum gain from the property.
3. Tax advantages
Another advantage of real estate investing is the tax breaks and deductions. Taxes are one of the biggest expenses for anyone, so this is a huge incentive for most people. For example, rental income is not subject to self-employment tax.
The government also offers tax breaks for the following:
Investing in an industry like real estate is important, because you are also entitled to lower tax rates for your longer term investments.
The cost of buildings may depreciate over time, but never the cost of the land. Since the cost of buying and improving an investment property can be depreciated over its useful life, you benefit from decades of deductions that help lower your taxed income. The average useful life of a residential property is 27 and a half years, and 39 years for a commercial property.
There is also something called a 1031 exchange. 1031 exchanges lets you defer your capital gains taxes once you sell one property and exchange it for a similar property.
The more formal definition is below:
The term 1031 Exchange is defined under section 1031 of the IRS Code. (1) To put it simply, this strategy allows an investor to “defer” paying capital gains taxes on an investment property when it is sold, as long as another “like-kind property” is purchased with the profit gained by the sale of the first property.
4. Portfolio diversification
Another benefit of investing in real estate is the ability to diversify your assets.
Many people hesitate to get involved with real estate investing because investing in stocks takes just a few clicks.
Investing in the stock market is fine, but you never want to have all of your eggs in one basket.
A huge advantage of real estate is the low, and sometimes negative, correlation it has with other major asset classes. This means the addition of investment properties to your portfolio can lower its volatility and provide a higher return per unit of risk.
Not unlike real estate, playing the stock market has become synonymous with high returns for those that know what they are doing. However, it is just that: playing a game. Investing in the stock market is a sure way to be completely in control of your investment.
If you invest in stocks, you will be at the mercy of a relatively volatile market, and it takes much more knowledge to make good investments in the stock market.
That said, real estate investing is the polar opposite, in regards to certain aspects of investing in stocks, like:
Net earnings in real estate are reflective of your own actions.
You are really in control of your own money.
Any money gained or lost is a direct result of what you do, rather than an unstable economy.
Ever wonder how your average person with a 9-5 job is able to buy a couple $100k+ properties per year? It is because they are using leverage.
Leverage is the use of various financial instruments or borrowed capital (ex. a mortgage) to increase an investment's potential return.
With leverage, you can buy a $100,000 property by only putting $20,000 down. The rest, you can borrow from a bank (mortgage) or borrow it from a hard money lender.
The mortgage is your borrowed capital that gets paid by the tenant's rent. Banks are more willing to let you borrow capital for this kind of investment, because real estate is a tangible asset and one that can serve as collateral.
So, instead of buying one property for $100,000 upfront, you are able to buy 5 properties for $20,000 down on each.
Leveraging money also allows you to initiate more than one real estate deal at a time because all of your funds are not tied up in one project.
As you pay down a property mortgage, you build equity—an asset that's part of your net worth. And as you build equity, you have more leverage to buy more properties and increase cash flow and wealth.
It is a continuous cycle that will usually have prosperous results.
6. Inflation hedge
The final advantage of real estate investing is that it is hedged against inflation.
Inflation is defined as a sustained increase in the general level of prices for goods and services. Essentially, inflation prevents your money from going as far as it would have.
Stocks, for instance, require more money to purchase with the increase of inflation. Real estate, on the other hand, serves as a hedge against inflation. Unlike almost every other form of investment, real estate reacts proportionately to inflation.
As economies expand, or inflation increases, the demand for real estate drives rents higher. So, your rental income and property value actually increase substantially.
Therefore, real estate tends to maintain high price by passing some of the inflationary pressure on to tenants and by incorporating some of the inflationary pressure in the form of capital appreciation. This is because as the cost of living goes up, so does their cash flow.
The inflation hedging capability of real estate comes from the positive relationship between GDP growth and the demand for real estate. Again, with gentrification comes appreciation and inflation.
Investing may sound scary for beginners, that is why real estate investing is the perfect way to get your feet wet when you are just starting out.
If done correctly, you can build generational wealth for your family for years to come. You also get to be your own boss. It doesn't get much better than that.
Real estate is a distinct asset class that's simple to understand and can enhance the risk-and-return profile of an investor's portfolio.
To recap, real estate offers cash flow, tax breaks, equity building, high appreciation, and a hedge against inflation. Real estate can also enhance a portfolio by lowering volatility through diversification.
Remember, before you dive into real estate investing, or any form of investment for that matter, you always want to consider the risk.
If you want to reap financial rewards from investing in real estate, you have to make wise and calculated investment decisions. This will grow and diversify your portfolio. Learning how to make these investment decisions in real estate is much easier than learning to master the stock market.
You always want to guarantee you are only investing enough money to where, if you lost everything, your life would not be drastically affected. No investment is worth losing your life's savings.
While there is no magic formula, it is all about studying your potential investment before closing any deal.