Updated: Feb 18
Real estate is one of my favorite asset classes to invest in. There are significant advantages to investing in real estate not normally known by the average investor and not offered by other asset classes.
1. Cash On Cash Return
Investing in rental properties can produce significantly high cash on cash return in the 15 - 20%, if managed properly. Since banks only require you to put 20 - 25% down for rental properties, your cash on cash return is measured against your down payment as opposed to the purchase price of the house.
As an example, if you purchase a property for $100,000, you would be required to put down $20,000 as a down payment (plus $5K for closing costs). If you were able to rent it out for $1,000/month you would be able to achieve a cash on cash return of 16%!
2. Tax Benefits
Investing in real estate allows you to offset your taxable rental income with depreciation of your asset. You can depreciate the value of the property as well as any capital improvements you've made on the property. In addition, when you sell your real estate, you can avoid paying long-term or short-term capital gains by doing a 1031 exchange. This allows you to leverage your appreciation and the equity in your rental property to purchase a bigger piece of real estate, which can earn you more cash in the form of rental income!
3. Equity Build Up
With real estate, you can increase the amount of equity in your rental property through forced appreciation, natural appreciation, or by simply paying down the mortgage! Forced appreciation can be achieved through renovations or repairs while natural appreciation occurs when property values in your market increase due to external factors such as changes in job or economic conditions. In addition to great cash on cash return, your equity in the property increases with every principal payment applied to your mortgage.
One of the greatest benefits of investing in real estate is the ability to use leverage, or debt. Can you name another investment that allows you to only assume 20% of the risk yet enable you to keep 100% of the profits? That's what you're doing when you buy real estate. You are only risking your down payment (typically 20%), while your bank risks the remaining 80% required to purchase the property. When you eventually sell your property, you get to keep 100% of the profits after the bank has been paid the remainder of their loan!
5. Inflation Hedge
Real estate offers great protection against inflation. As inflation rises, so do property values, and so does the amount a landlord can charge for rent, earning higher rental income over time. This helps to keep pace with the rise in inflation. It is a much better option than keeping your cash in a savings account, where your money would lose purchasing power because the interest your bank offers you (<1%) is less than the average inflation rate (2.3%).
6. Physical Asset
Real estate is a real, physical asset that you can see and touch. Real assets provide portfolio diversification, as they often move in opposite directions to financial assets like stocks or bonds. Real assets tend to be more stable but less liquid than financial assets, such as stock and bonds. As you can see in this graph, housing prices have climbed steadily over the past 60 years and don't exhibit the same volatility seen in the stock market over the same time frame.