So, you’re interested in real estate investing. Where do you start? Real estate is a complex business and there is a lot that goes into it! The best way to start out in the real estate investing world is to simply learn as much as you can. Start with real estate books, listen to podcasts, and read blogs (like this one!). Today, we’re going to walk through the five main benefits of investing in real estate.
We’ll be talking about real estate investing in the traditional, buy and hold sense of the word. We won’t be covering REITs (real estate investment trust), wholesaling, house flipping, etc. This is good old-fashioned, passive-rental, wealth building real estate.
Okay, so our first main benefit of real estate is Income. Income comes from the monthly rent paid to you each month by your tenant. What is left over after expenses is called “cash flow”. Income from a rental property is a great hedge against inflation as housing expenses (a.k.a rent) usually increase about 2% a year. This is the same rate at which inflation is usually tracked. This is the key to financial independence. Without income, you will eventually run out of money if you are drawing from your savings account or pulling from the principle of other investments.
Our second main benefit of real estate is Depreciation. Depreciation is a huge tax advantage of owning rental properties. Divide the home’s price by 27.5 yrs and that’s what you can deduct each year from your rental income. In essence, depreciation is accounting for a decrease in value from average use and wear and tear. You can also depreciate certain capital expenses over a period of time, such as replacing a roof or installing a new HVAC system. This can help provide even greater depreciation deductions on your annual taxes. However, depreciation can only be used on investment properties, which makes it a valueable tax advantage available only to real estate investors.
Another “D” benefit is Deductions. Certain expenses can be deducted relating to arental investment property, which may include: property tax, property insurance, mortgage interest, or property management fees.
#3 BUILDING EQUITY
Our third main benefit of investing in real estate is Building Equity. Your tenant pays down the loan you used to acquire the property, thus increasing your amount of equity over time. Your mortgage payment is made up of principal and interest. THis means everytime you make a mortgage payment, part of that payment is going towards your equity (or how much of the home you actually own).
Our fourth main benefit of rental real estate is Appreciation. In real estate, appreciation refers to the increase in value of a property over a period of time. Regardless of short term market corrections, home values will increase over time (estimated at 4%/yr in stable markets). This appreciation increases the amount of equity you have in the home over time. Appreciate the appreciations.
And last but certainly not least, is our fifth main benefit: Leverage. Leverage is what really explodes your returns on investing. You get to put in only a small percentage of the capital to buy the home, but you receive 100% of the tax & income benefits! Typically, you will borrow money from a lender to purchase a home rather than having to cover the entire purchase price by yourself. It is a method to help increase the potential return on your investment.
Let’s start off with an example comparing real estate investing to stock market investing. We’ll use an initial investment of $20,000 for our example.
If you purchased stocks, you would only have $20,000 invested. If those stocks went up 5% that year (appreciation), you would now have $21,000 and would have realized a true 5% return. However, there are no advantages from income, tax benefits, equity buildup, or leverage.
Let’s take that same initial investment of $20,000 and apply it to a rental property investment. You borrow (leverage) $80,000 to purchase a $100,000 home.
Let’s say that home went up 5% that year and is now worth $105,000. You have $25,000 in equity and realized an actual return of 25%! This comes from your initial investment of $20,000 plus the $5,000 (5% appreciation).
Say the home produces $200/month in cash flow ($2,400/yr). Just from the income you are receiving a 12% return ($2,400/yr rent income divided by the $20,000 down payment).
This still doesn’t include the returns you would receive from tax benefits through depreciation or equity buildup as the tenant pays the loan for you!
Do you see how all these factors can be added to produce an enormous return? Even the income alone of 12% will easily beat stocks’ suggested 7% annual return over time.
There is a reason why more millionaires have been made through real estate than any other investment. It’s math, not magic!
Investing in rental real estate is a passive process. You don’t have to do much to keep this type of investment going. Unlike investing in a small business like a retail store or restaurant, residential real estate does not require a lot of supervision to make great returns.
If you are heavily invested in the stock market because that’s what you were told by your parents and employer to do (we’re not dismissing their opinion), it’s never too late to add real estate to your portfolio. Real estate investing can help hedge against more risky investment numbers in the stock market. Real estate is a great hedge against inflation and the volatility of the stock market. It just keeps chugging along, building you wealth over time.
In our opinion, the best part of real estate investing is the control factor. The fact that you get to choose how to use your investment and the abundant ways to utilize it! Real estate is tangible and has physical utility to it, unlike the stock ticker you watch on your computer. Don’t let the “financial wizards” of Wall Street eat you alive with fees and financial trickery when you invest in stocks, bonds, mutual funds, and ETFs. Real estate is very simple, easy to understand, and it just makes sense.
Like Warren Buffet says: “Invest in what you know… and nothing more.”
Now that we’ve covered some of the amazing powers of real estate, I hope you are convinced to invest in rental properties.
Rent to Retirement will continue to be here to help you understand real estate, further your overall financial education, and show you the path to a successful future in real estate investing. Nobody deserves to be left helpless in the traditional retirement dust.