If you're looking for a solid investment, you have many choices. Over many years, however, real estate has been one of the most popularly and widely recommended investments. There are quite a few reasons for this. Before investing, it's important to consider your unique needs, personality, and budget. However, real estate is an investment worth considering regardless of your situation. Let's look at the top 5 reasons to invest in real estate.
- Price Appreciation
All investments, including stocks, bonds, gold, art, and real estate, fluctuate in value. There are periods when prices rise and when they decline. Over time, however, real estate prices tend to increase. If you look at housing prices in the United States over the last century, you'll see a fairly steady rise. Of course, there are exceptions, such as the housing crisis of 2008. However, we are talking about long-term trends.
The fundamental reason that real estate tends to increase over time is scarcity. Populations increase, developers build new homes and businesses, yet there's a fixed amount of land. This doesn't mean prices constantly rise. As with all investments, there are inevitably fluctuations in the market. It's also necessary to look at factors other than prices, such as inflation and associated costs with real estate investing. However, even taking into account all of these factors, property, homes, and other real estate investments tend to appreciate over time.
- Lower Risk than Other Investments
Unlike many investments, real estate is a hard asset. Put another way, it has intrinsic value. For many investments, values are highly subjective. The value of dollars, stocks, bonds, precious metals, stamps, collector's items and other investments depend on complex conditions and public perception as well as economic conditions. The same is true, to some extent, for real estate. The difference is that real estate always has intrinsic value. People need shelter and places to build homes and businesses.
If you buy a home or other physical structure, both the building and property are hard assets with enduring value, regardless of economic conditions. While prices often fluctuate, real estate is never worthless. By contrast, if you invest in a stock and the company goes bankrupt, your investment is worth zero. A home or piece of land, however, always has a certain intrinsic value. This is why real estate is low risk compared to many other investments, including stocks, commodities, and Forex. When you invest in a company, currency or commodity, you are subject to the whims of the marketplace. With real estate, you always have physical assets, not just a piece of paper, that are always be in demand.
- Ability to Leverage Investments
Leverage is a crucial principle in the world of investing. Leverage allows you to use money or resources beyond what you actually paid out-of-pocket. A common example is when you buy a house with mortgage financing. Suppose, for example, you have $300,000 to invest. Let's further suppose that you are buying real estate to earn extra income and you aren't planning to live in the house yourself.
Without leverage, your investing budget is only $300,000. But with a mortgage, you typically only need 20% of the total price as a down payment. This lets you buy a home or apartment worth $1.5 million. Leverage allows you to get more from appreciation as well. Keep in mind that property appreciation applies to the property value rather than the amount you invested, which means your return is multiplied compared to what it would be without leverage. In addition, 20% is a typical down payment, but many real estate investors find more favorable deals. If you only put 10% down, for example, you have double the leverage.
Just as leverage increases the potential for profit, it also lowers risk for investors. When you only put down a small percentage of a property's value, you are limiting your own investment. The financial institution lending the money shares the risk. Real estate investors who buy office complexes, apartment buildings, hotels, and other commercial properties apply this principle on a grand scale. It's one of the reasons that many people make fortunes in real estate.
- Tax Benefits
Tax benefits are another attractive feature of real estate investing. There are many ways that investing in real estate cuts your tax bill. One of the most common strategies is to claim tax deductions such as depreciation. All properties, along with appliances and fixtures, depreciate due to natural usage over time. Other tax deductions include normal expenses such as insurance and utilities. Even interest on your mortgage is tax-deductible.
Investors often sell properties for a profit. The IRS, naturally, takes a cut of these profits. However, tax conditions favor real estate investors who own their property for more than a year. This is due to the difference between short-term and long-term capital gains tax rates. Short-term capital gains taxes, which apply to investments bought and sold within a year, are quite substantial, as high as 39.6%, depending on the size of the gain. This is one of the downsides to "day trading" stocks; when you make fast profits, you're liable for high capital gains taxes. Most real estate investors, by contrast, hold properties for some time. Of course, if you buy and sell (or "flip") a property in less than a year, you're liable for short-term capital gains. In some cases, it's worth it to pay higher taxes for a quick profit. However, most real estate deals involve owning properties for a longer duration. To get the benefits of lower long-term capital gains rates you will have to own the property for a year. In this case, your tax rate is only 15%, 20%, or 23.8%, depending on the total amount of the gain.
Still another powerful tax benefit of real estate investing are 1031 exchanges. This is a tactic that lets you invest real estate profits into future real estate investments while deferring the capital gains taxes. Sophisticated investors will virtually avoid paying any taxes on profits through this technique.
- Hedge Against Inflation
Economists discuss concepts such as inflation, deflation, and recession in various ways. Put simply, inflation means a general increase in prices and fall in the purchasing value of money. Even during periods of supposedly low inflation, prices of many necessities and commodities rises. Rising real estate prices and rents are one of the most painful effects of inflation - unless you're a real estate investor.
Real estate protects you from the harmful results of inflation. When inflation causes the price of your property to go up, you can always sell it at a profit. If you are renting the property, you raise the rent in response to market conditions. While your gains are offset by your own expenses (which also rise during periods of inflation), you at least avoid falling behind. This is why real estate is an effective hedge against inflation.
What about when there is no inflation or even deflation? During these times, real estate values remain stagnant or even drop. However, as mentioned, owning hard assets protects you. It's worth noting that even when economists and the government claim we are in a period of deflation, rents, and other essential expenses remain stable or even rise. Rent, like food, is a necessity regardless of economic conditions. That's why prices tend to remain stable during deflation while prices of discretionary products (e.g. entertainment) go down. Thus, there are benefits to owning real estate whether prices in general are rising or falling.
- Real Estate: A Solid Investment
We've looked at some of the most compelling advantages of real estate investing. What makes real estate different from other types of investment is its enduring value regardless of economic conditions. Naturally, conditions such as politics, taxes, and inflation affect real estate investors as they do everyone else. However, owning hard assets that people always need protects you from the downsides associated with other investments.