Real estate is a timeless asset class because shelter is a basic human need. You cannot outsource it and technology cannot replace it.
As you read this article, you will discover the reasons why so many wealthy people invest in real estate to create, grow, or preserve their wealth, and why you should consider allocating a portion of your portfolio to this asset class.
Generally, the value of real estate increases over time. As the value increases, your equity in the property will increase with it. You can later refinance out the newfound equity and use it to purchase additional properties or simply sell the property for a profit.
When investing in multifamily, you can actually force appreciation by adding value to the property, increasing rents and ancillary income, and lowering expenses.
Leverage allows you to purchase a larger asset with less cash. For instance if you have a $100k you can generally purchase a $400k property using the common 75% LTV (loan-to-value) ratio.
Banks are willing to lend to real estate investors because the property is used as collateral. It is harder to receive this type leverage in other business and using leverage in the stock market can carry much more risk due to volatility.
Principle Pay Down
Another benefit of using leverage is principle pay down. Not only can you purchase a larger asset but your tenants will be paying down the mortgage. As the payments are made, a portion of the loan principle is paid down and your equity increases.
A popular benefit of investing in real estate is cash flow, sometimes called “passive income”.
If you buy, finance, and manage the property correctly then the property should be generating positive cash flow. That is money that you can put in your pocket every month, use to improve the property, or buy additional properties.
Tax benefits are arguably one of the biggest reasons people invest in real estate.
For starters, taxes are paid on the net income (income – expenses) of the property, which means expenses related to the property are tax deductible.
Next, there’s depreciation, which is a non-cash expense. Residential real estate depreciates over 27.5 years and commercial real estate over 39 years. There are a handful of accelerated depreciation methods that allow you to capture the depreciation early.
In some cases, the depreciation expense is so high that the property shows a net loss, and there is little or no tax paid on the income from the property.
Capital gains tax is paid when you sell the building for a profit. Short-term capital gains, property held for less than a year, is taxed as ordinary income. Depending on which tax bracket you are in your ordinary income can be taxed up to 39.6%. However if the property is sold after holding it for longer than a year then it becomes a long-term capital gain, which is taxed at a max rate of 20%.
Finally, there’s the 1031 exchange, which allows an investor to sell the property and defer the capital gains tax if the profit is put toward the purchase of another property. If you bought a property in 2016 for $100k then sold it in 2018 for $150k, you can use the entire $150k to buy another property and defer paying taxes on the $50k capital gain.
The Bottom Line
The tax benefits, use of leverage, and use of principle pay down are not only great ways to create, grow, or preserve your wealth, but are hard to find in other asset classes.
If you are interested in learning more why you should consider investing a portion of your portfolio in real estate then you can download our free ebook by clicking here