Why Investing in Real Estate is Good
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Investing in real estate can be one of the best ways to accumulate wealth. Wealth grows through compounding, which means investing money into something on the expectation that you will receive more money back later on.
Real estate has been a consistent wealth compounder for a simple reason: there’s only so much land to build on! Real estate harnesses the power of supply and demand and channels it into your portfolio. Fundamental rules of supply and demand tell us that a limited supply of something in high demand must result in higher prices.
Fortunately, you do not need to be an ultra-high net worth person to get started in real estate investing. While investing in real estate does come with potential pitfalls and requires research, it can also bring plenty of cash to your bank account.
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. On its own, real estate offers cash flow, tax breaks, equity building, competitive risk-adjusted returns, and a hedge against inflation.
It can also enhance a portfolio by lowering volatility through diversification, whether you invest in physical properties or REITs. The goal is to invest in properties that increase in value over time. If you understand the risks and are willing to do the research, finding the best places to invest in real estate could provide you with a solid income boost.
The key is to do your research to find out which type of real estate investing is the best fit. The benefits of investing in real estate are numerous. With well-chosen assets, investors can enjoy predictable cash flow, excellent returns, tax advantages, and diversification and it's possible to leverage real estate to build wealth. Here are some of the most important reasons why investing in real estate is good.
You’ll need to research the payment histories of your tenants if you want to reduce the chance that they may one day default on paying their rent.
Steady Cash Flow
Cash flow is the net income from a real estate investment after mortgage payments and operating expenses have been made. A key benefit of real estate investing is its ability to generate cash flow.
Owning real estate is a way to boost your monthly income. Whether you invest in commercial real estate or residential, you can rent out your space to tenants. You’ll then receive monthly rental income.
Great Returns
Real estate values tend to increase over time, and with a good investment, you can turn a profit when it's time to sell. Rents also tend to rise over time, which can lead to higher cash flow. If the real estate you own increases in value over time, you can sell it for a solid profit.
Remember, appreciation isn’t guaranteed. You’ll need to invest in the right property to see those big returns. Real estate investors make money through rental income, any profits generated by property-dependent business activity, and appreciation.
Long-Term Security
Real estate is a long-term investment, meaning you can hold it for many years as you wait for it to appreciate in value. Alternatively, you can rent out your real estate and earn monthly income while you wait for your property’s value to rise.
Tax Advantages
Investing in real estate comes with tax benefits. Real estate investors can take advantage of numerous tax breaks and deductions that can save money at tax time.
You can deduct several expenses associated with owning an investment property, including your property taxes, mortgage interest, property management fees, property insurance, the costs of ongoing maintenance, the cost of repairs and the money you pay to market your property to potential tenants.
If you sell your property for more than you paid for it, the gain you realized won't be taxed as income. Instead, it will be taxed as capital gains, which usually comes with lower tax rates than does income.
If you invest in neighborhoods that are in need of investment, you'll pay even less in capital gains. You can deduct the reasonable costs of owning, operating, and managing a property.
Since the cost of buying and improving an investment property can be depreciated over its useful life (27.5 years for residential properties and 39 years for commercial), you benefit from deductions that help lower your taxable income.
Portfolio Diversification
The addition of real estate to a portfolio of diversified assets can lower portfolio volatility and provide a higher return per unit of risk. Adding real estate to your investments boosts your diversification, which can protect you in times of economic turmoil.
Real estate has a low and in some cases negative correlation with other major asset classes.
Passive Income
The rent checks that come in each month are an example of passive income. Investment rental properties bring much desired passive income, that which you don’t have to work for every day. For instance, you may charge rent on a single-family or multifamily property you own.
A 20% down payment on a mortgage, for example, gets you 100% of the house you want to buy, that's leverage. Because real estate is a tangible asset and one that can serve as collateral, financing is readily available.
Ability To Leverage Funds
Leverage in real estate means you’re using other people’s money to purchase properties. In this case, you’ll take out loans from banks, mortgage lenders or credit unions and pay them back over time.
This allows you to buy real estate holdings without spending the full amount of money you’d need to purchase them on your own.
When investing in real estate you probably can’t afford to buy properties in full. That’s where leverage comes in. Leverage is the use of various financial instruments or borrowed capital (e.g. debt) to increase an investment's potential return.
Protection Against Inflation
Real estate investments are considered protection against inflation. When the prices of goods and services are rising, home values and rents usually tend to increase. There are several ways that owning real estate can protect against inflation.
Investment properties can provide you with rising monthly income and appreciation to help protect you financially when the costs of everything else is going up.
Property values may rise higher than the rate of inflation, leading to capital gains. Rental income on investment properties can increase to keep up with inflation. And properties financed with a fixed-rate loan will see the relative amount of the monthly mortgage payments fall over time as a fixed payment will become less burdensome as inflation erodes the purchasing power of the currency.
The inflation hedging capability of real estate stems from the positive relationship between GDP growth and the demand for real estate. As economies expand, the demand for real estate drives rents higher. This, in turn, translates into higher capital values.
Real estate tends to maintain the buying power of capital by passing some of the inflationary pressure on to tenants and by incorporating some of the inflationary pressure in the form of capital appreciation.
Chance To Build Capital
When you sell a property that has risen in value, you’ll boost your capital. The key, of course, is to invest in the right properties that will rise in value.
The big goal of real estate investing is to increase your cash, otherwise known as building capital.
Fulfillment And Control
Owning investment properties comes with other benefits that aren’t financial. When you own investment real estate, you are your own boss, which is fulfilling to many investors.
You can also make a difference in your community, providing homes for renters or bringing businesses to commercial properties that will provide much-needed services to their communities.
Real Estate Vs. Mutual Funds
Mutual funds are a long-term investment. If you hold onto your mutual fund investments long enough, they’ll increase in value, though appreciation is not guaranteed. It’s easier to invest in mutual funds than in real estate.
Real estate investments, though, can provide a hedge against the economic downturns that can cause mutual fund investments to fall in value.
How Real Estate Compares To Other Investments
Here’s a look at how real estate compares to other popular investment types.
Real Estate Vs. Stocks
Real estate is less volatile than stocks, whose value can rise or fall more quickly. Real estate is less liquid than stocks: It’s easier to sell your stocks and gain access to your money than it is your real estate investments.
Real Estate Vs. Bonds
Bonds are one of the safer investments. You usually won’t lose money by investing in bonds. Their gains tend to be smaller, though.
You have the chance to make higher gains by investing in real estate, though your risk of losing money is much higher.
Real Estate Vs. CDs
Investing in CDs is similar to investing in bonds: These are among the safest of investments, and it’s rare to lose money when investing in them. But like bonds, your gains are often much lower than what you might earn when you invest in real estate.
The Challenges Of Investing In Real Estate
While investing in real estate brings the potential for a huge payday, it also comes with some challenges and risks.
Liquidity
Real estate is not a liquid investment. Once you invest your money into a property, you’ll have to sell that property or a portion of it that you own to get your money. Other investments, such as stocks and bonds, are far more liquid. It’s easy to sell stocks to get access to your money.
Starting Capital
You’ll need more money to get started investing in real estate. Properties aren’t cheap. You might need to apply for mortgage loans to purchase a property. Investing in mutual funds, CDs and stocks usually requires far less capital to start.
Time
Profits don’t come quickly with real estate investments. You may charge rent to commercial or residential tenants. But often these payments only cover the cost of your mortgage payments or the other costs associated with maintaining an investment property.
The big profits come when you sell the property for more than what you paid for it. To hit that goal, though, you often must wait several years for your property to increase in value.
Location
Location is key when investing in real estate. Your property probably won’t increase in value if it isn’t located in a community where real estate prices are on the rise. This means you’ll have to do more research to find the right investment property in the right location.
Participate in a “Mini-IPO”
Now, anyone can invest in a private company in what’s known as a “Reg A+” offering or “mini-IPO.” Unlike a traditional IPO, the fees and ongoing disclosure requirements the private company would be obligated to complete are much less burdensome under Reg A+.
The JOBS Act legislation is welcome news for investors who want to participate in private real estate deals but do not meet the income or net worth accreditation requirement.
Still, approach these investments cautiously since there can be significant risk investing in early-stage companies or real estate development projects.
Invest in a Private Debt Fund
Private debt funds pool your capital in exchange for an equity position in the company formed to lend money to finance real estate projects.
Investors in these types of funds are looking to diversify their source of income or replace an existing investment for one with a higher yield.
These funds may be more attractive than equity funds if you have a shorter time horizon and a lower risk tolerance.
Residential Properties
You can then either live in the property or rent it out as you wait for it to appreciate in value. If you rent out the property, you might be able to use these monthly checks to cover all or part of your monthly mortgage payment.
Once the property has appreciated enough in value, you can sell it for a big payday.
You should also work with real estate agents and other professionals who can you show historic appreciation numbers for the communities you are targeting.
You will have to be mindful of location. A home on a busy street might be more affordable but might not appreciate as quickly as one located on a quiet side street.
You can lower the odds of a bad investment by researching local neighborhoods to find those in which home values tend to rise.
An apartment building located next to public transportation might see a quicker jump in value than one located miles away from the nearest commuter train station.
If you don’t want to take phone calls late at night from tenants complaining about furnaces that aren’t working or roofs that are leaking, you’ll have to pay a property management service.
These services handle the daily work of maintaining and operating properties. They’ll also send repair technicians to properties that need emergency maintenance.
Sinking your money into investment properties can also prove lucrative, though it does require some work. The challenge, of course, is that the property you purchase isn’t guaranteed to increase in value.
Commercial Properties
You can earn money by purchasing and investing in commercial properties much the same way you do by investing in residential real estate.
There are many types of commercial properties in which you can invest. You can purchase an office building and charge companies to rent space in that building.
You can purchase strip centers or other retail properties and charge monthly rent to business owners. You can even purchase a warehouse and charge rent to manufacturing companies or retailers who need to store their products.
If the property’s value rises, you can sell the commercial space for a hefty profit. The risks are the same as they are when investing in residential real estate.
There is never a guarantee that your commercial properties will increase in value, which is why researching the properties and the communities in which they sit is so important.
You may also struggle to find enough tenants to fill that office building or retail center you bought.
House Flipping
Investors who want to make money quickly often turn to house flipping. This is when you purchase a home for a lower price, renovate it quickly and then sell it for a fast profit. The key, of course, is to buy the right home.
You’re not interested in monthly rents when flipping a home. Instead, you need to buy a home for the lowest possible price if you want to make a good profit when selling. Research is key.
You want to find a home in an attractive neighborhood, one that attracts plenty of buyers. And you need to make sure the repairs required for the home aren’t so costly that they’ll swallow any potential profit.
If you’re handy enough to handle renovations on your own, you’ll greatly improve your chances of making solid profits through house flipping.
Popular Ways to Invest in Real Estate
There are many ways to invest in real estate. The right way should be to balance your investment objectives, risk tolerance, time horizon, and net worth.
Real estate offers an enviable combination of historically strong returns and passive income, as well as the potential to hedge inflation and the gyrations of the stock market.
With only so much land to build on, the opportunity to accumulate and perpetuate wealth should continue to accrue to those who own and invest in real estate.
Your net worth, risk tolerance, and current income-oriented investments are some of the factors that should help guide your choice. Investing in real estate can be an excellent way to grow your net worth. Here are some of the most popular ways to invest in real estate.
Invest in a Private Equity Fund
Investing in a private equity real estate fund means trading your capital for an equity position in the company formed to develop, operate, or manage a single-asset property or portfolio of commercial properties.
Private equity funds offer real estate projects and you should be able to find an investment that aligns with your investment objectives, risk tolerance, and time horizon. Private equity real estate funds fall into one of four risk profiles: core, core plus, value-add, and opportunistic.
Core/core-plus private equity deals share characteristics with REITs. These properties already produce income from high-quality tenants, are in the nice parts of town, and have low amounts of debt. They may be appropriate if you’re looking for income-generating investments and have lower risk tolerance.
Value-add private equity deals are the same as renovation jobs. Basically, the private equity manager uses your capital to fix up a property or portfolio of properties.
Then, the manager may choose to keep the property and pass the income from the tenants back to you or sell it and pay out the proceeds of sale according to your equity position.
These deals offer the potential for higher returns either through income or exit than core deals but come with higher risk.
Opportunistic private equity deals are ground-up development projects: you trade access to your capital to build something new. These deals can include redevelopment, land acquisition, and new builds.
These deals may be appropriate if you want to complement existing income-generating or low-risk investments with a high-risk/high reward growth-oriented investment.
Invest Capital Gains In A Qualified Opportunity Zone
Here, you invest unrealized capital gains in opportunistic development deals. In doing so, you can potentially:
Defer taxes due on your initial gain, while earning an investment return on your deferred tax along the way.
Earn a significant tax benefit and pay no tax on growth in the value of your investment for your entire holding period, assuming a minimum of a 10-year hold.
Help qualified communities revitalize by generating both socio-economic opportunities through commercial real estate projects.
Depending on the project, you may also realize a potentially attractive exit multiple upon the sale of the property.
Opportunity Zones are most appropriate for accredited investors with a high-risk tolerance and a long time horizon. In addition to taking on development risk, you must wait ten years and follow a strict timeline to realize the tax benefits.
Invest in a REIT
If you want to invest in real estate, but aren't ready to make the jump into owning and managing properties, you may want to consider a real estate investment trust (REIT). You can buy and sell publicly-traded REITs on major stock exchanges.
A REIT is a company that owns, operates, or finances income-generating real estate such as apartment buildings, hotels, offices or warehouses. REITs must pay out 90% of income to investors, so they usually offer higher dividends than many stocks.
Real estate investment trusts (REITs) are a popular way to invest in real estate. The company must meet several requirements to qualify as a REIT.
Principally, 75% or more of the portfolio must invest in income-generating real estate, and 90% of the income generated by these properties must be distributed as a dividend to shareholders.
Buying into a real estate investment trust is one of the easiest ways to invest in real estate. With a REIT, you invest in real estate without having to worry about maintaining or managing any physical buildings.
When you buy into a REIT, you purchase a share of these properties. It's a bit like investing in a mutual fund, only instead of stocks. You can earn money from a REIT in two ways:
REITs make regular dividend payments to investors.
If the value of the REIT increases, you can sell your investment for a profit.
You can invest in a REIT just as you would invest in a stock. REITs are listed on the major stock exchanges. REITs can be publicly traded and non-traded. Publicly traded REITs trade on exchanges like the New York Stock Exchange.
Anyone can invest in the REIT. Publicly traded REITs are highly liquid, meaning you can buy or sell the shares quickly on the exchange. Liquidity can be good if you need to quickly access your capital.
Non-traded REITs are subject to the same requirements as their public counterparts but are highly illiquid. Investing in a non-traded REIT means locking up your money for two to five years, usually in exchange for potentially higher dividends.
REIT prices often fluctuate with the general direction of the stock market, regardless of the value of the properties in their portfolio.
REITs may be a good fit for a dividend-based way to grow your retirement account rather than provide growth via price appreciation.
Complete a 1031 Exchange
Completing a 1031 exchange is one of the most popular ways to accumulate wealth using real estate. The regulations require the exchanged property is for investment use only (can’t be your primary residence) and that you exchange for a new property at an equal or greater value. Currently, there is no limit to the number of exchanges an investor may complete.
There’s a web of regulations, timelines, and requirements that accompany a 1031 exchange, so they are far from simple to execute. All those steps aside, the idea is simple: swap one property for another and defer capital gains taxes forever.
1031 exchange properties may be appropriate for someone in a high tax bracket to accumulate wealth for their estate or to expand and diversify an existing real estate portfolio.
Invest in a Syndicate
Syndication is an established method for raising capital to purchase one property. You trade access to your capital for an equity position in the general partnership formed to buy an existing property.
You are a limited partner who receives passive income and has no oversight or management responsibility. A syndicate can diversify your current source of income or replace an existing investment for one with a higher yield.