I’ll return to my series “The Case for using a Buyers Agent” shortly, but the attached article was just to good to pass up. Hats off to author Ken Holman for his succinct statement regarding the benefits of investing in real estate that supports my mantra: real estate is the superior investment opportunity. Ken is the President of The National Association of Real Estate Investment Advisors:
Seven Reason Real Estate is a Superior Investment | By Ken Holman
As with any investment, real estate has its advantages and disadvantages. Some naysayers would claim that real estate investing requires a substantial amount of capital. Others would argue that it is management intensive and lacks liquidity. Still, others maintain that it is too complicated. While there is some merit to these so-called disadvantages, some distinct advantages are unique to investing in real estate. Listed below are some of the advantages that make real estate a superior investment to other forms of asset accumulation.
Cash Flow
1. Real estate offers a predictable cash flow. Cash flow is the net spendable income derived from the investment after all operating expenses and mortgage payments have been made. A good real estate investment, whether it’s a residential or a commercial property should achieve a 6 to 10 percent positive cash flow. On the other hand, the average dividend for the typical stock investment averages just more than 2 percent.
Appreciation
2. Real estate consistently appreciates in value. Appreciation is the increase in value over the lifetime of a property due to inflation, supply and demand, capital improvements and other factors, such as change in use. Since 1968, appreciation levels for real estate have been 6 percent per year, including the downturn in the economy beginning in 2007, according to the National Association of Realtors (NAR). Unlike real estate, the Dow Jones Industrial Average has fluctuated wildly over certain decades, showing little progress in the overall.
Leverage
3. Real estate can be leveraged. Leverage is the use of borrowed capital to increase the potential return of an investment. In real estate transactions, leverage occurs when a mortgage is used to reduce the amount of investor capital required to purchase a property. The annual return on a $200,000 property with a $20,000 net cash flow purchased with cash is 10 percent. If 75 percent of the money required to purchase the property is borrowed, even factoring in the cost of making the mortgage payment, the annual return more than doubles to 22 percent (assuming a loan of $150,000 is amortized over 30 years at 5 percent interest). Because of its volatility, leverage an investment in stocks is difficult.
Equity Buildup
4. Real estate provides equity buildup. Most real estate is purchased with a small down payment with the balance of the money being provided through debt financing from a lender. Over time, the principal amount on the mortgage is paid down, slowly at first, and then more rapidly toward the end of the amortization period. This principal reduction builds equity.
Tax Sheltering/Avoidance
5. Real estate offers numerous tax advantages. The three most prominent tax advantages are depreciation, capital gains, and a tax-deferred exchange. Depreciation is a non-cash expense permitted by the Internal Revenue Service that reduces the amount of net income upon which taxes must be paid. For tax purposes, the IRS assumes a property depreciates in value over time. However, from an economic standpoint, the value of the property actually appreciates. The depreciation deduction allows a real estate investor to generate a positive cash flow while reporting a lower income for tax purposes. This creates a higher cash-on-cash return for the investor. When the asset is sold, after holding it for a year, the government permits the gain on the sale to be taxed at a significantly lower rate than the individual income tax rates, generally the rate is 15 or 20 percent, depending on one’s personal income tax bracket, compared to a rate as high as 39.6 percent. A 1031 Tax-Deferred allows the payment of taxes to be deferred on the sale of a property. The IRS permits the gain on the sale of the real estate to be transferred from the property being sold to a new property being purchased, hence deferring the payment of any tax on the sale of the property.
Intangible Benefits
6. Real estate offers other intangible benefits. The person owning the real estate has control over the asset. If inflation occurs, rents can be adjusted accordingly. If the market takes a downturn, rates can be adjusted to coincide with the economic conditions for the area. Real estate can be improved, which enables the asset to increase in value. Unlike the stock market, which occasionally has a company take out bankruptcy and eliminating the owner’s equity, real estate has intrinsic value. Its value never goes to zero.
Retirement Vehicle
7. Real estate coincides with retirement. When real estate is purchased, the cash flow is lower and the principal reduction on the mortgage is less. Over time, the mortgage is paid down or in some cases, completely paid off, and the cash flow increases. The income from real estate kicks in about the time a person is ready to retire. In some ways, it’s a forced savings program. Just as an investor is ready to retire, the passive income from real estate begins to supplant their earned income. As they age, their real estate holdings continue to appreciate in value and produce passive income to offset the effects of inflation. Real estate seldom diminishes in value, so it can be passed on to the next generation. Stocks, on the other hand, must be liquidated during retirement to provide sufficient income on which to live. In the end, one hopes their stock portfolio outlasts their life; otherwise they’re left with nothing. With a stock portfolio, little is left at the end of one’s life to pass on to the next generation.
Summary
As Ken McElroy, author of The Advanced Guide to Real Estate Investing, stated, “Real estate is the ultimate investment. Nothing else provides the same kind of dollar-for-dollar returns and has the same kinds of advantages. If I had a choice to invest $1 million in real estate or $1 million in … stock, I would choose real estate hands down. The reason is simple; even if the real estate investment appreciated at half the rate as the stock, I would still come out way ahead when taking into account leverage, tax advantages, and cash flow.” As an avid real estate investor for more than 30 years, I have learned ways to mitigate any disadvantages to investing in real estate. I have never found a better investment with more advantages. Real estate, and only real estate, provides a unique set of advantages that make it a superior investment over any other investment I’ve found.
About The Author
Kenneth T. Holman is president of Overland Group, RE/MAX Overland, and the National Association of Real Estate Investment Advisors. For more than 30 years, Mr. Holman has had extensive experience in the real estate industry, primarily in the areas of single family and multifamily residential, lodging, industrial, office, and free-standing retail. He is a licensed real estate broker, general contractor, mortgage loan originator, and teacher. Find our more about Mr. Holman at www.NAREIAGroup.org. He can be reached at KHolman@NAREIAGroup.org or 801.931.5571
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