Four Unfair Advantages of Investing in Real Estate

Written by Posted On Saturday, 17 April 2021 09:16

Stocks, bonds, cryptocurrency, precious metals. Countless asset classes are fighting to earn your investment dollars. But when it comes to choosing an asset class, there is one with numerous unfair advantages that helps set it apart from others. That asset class is real estate. Today, I’m sharing with you four unfair advantages of investing in real estate and why it’s worth considering for your portfolio. Without further ado, let’s jump right in!

1) Cash Flow

First, imagine investing in an S&P 500 index fund. While this is one of my other favorite asset classes, there is one area where this asset class falls short:  cash flow. As of this writing, the Vanguard S&P 500 index fund is yielding a measly 1.42% dividend.

With stocks, you’re stuck waiting for share price appreciation to earn your return. This means it’s tough to use stocks as a passive income source.

Real estate is different. If you choose to invest in rental properties (or other types of real estate investments), it’s pretty common to earn a high cash yield. For example, many real estate investors will seek an 8% cash yield on their real estate investments. 

What does this mean in practice? It means you can use real estate to build substantial passive income – often much more than other asset classes.   

2) Mortgage Paydown 

While cash flow is one of the top reasons real estate investors buy property, there’s another “hidden” wealth-builder embedded in real estate.

If you own rental property, not only are tenants paying you cash flow, but their rent pays down the mortgage on the property.

Imagine buying a $150,000 property and finance 80% of the purchase price on a 30-year mortgage at 4.0% (a starting mortgage balance of $120,000). 

While the mortgage payment would be around $572/month, approximately $170 per month would go towards principal (with that amount growing as the loan is paid down). 

Over a year, that means almost $2,100 of principal paid down thanks to the tenant. So, if you put $30,000 of equity into the house, and $2,100 of mortgage principal is paid down each year, this works out to a return of 7% on your money. 

3) Appreciation

Next, and this one is a biggie, is appreciation. Let’s use the example of a $150,000 and assume that it appreciates 2% per year. So, in the first year, the appreciation would be approximately $3,000.

But 2% appreciation isn’t much, right? Wrong.

If the property appreciates 2%, you earn $3,000 in the first year. But, that $3,000 is on an initial investment of $30,000. Said differently, the appreciation is a 10% return on your initial investment. 

How could that be?  The answer is leverage. In this example, you’re earning 100% of the appreciation on a house where you’ve invested 20% in equity. While using leverage can work both for and against you, it can help you increase your returns when used correctly.

4) Tax Advantages

Finally, there is one advantage of real estate investments that is hard to beat. Unlike most asset classes, real estate investments are tax-advantaged.

If you own rental property, the government requires you to take something called depreciation expense. In a nutshell, this reduces the taxable income on which you will owe taxes.

Let’s assume your property produces $5,000 of income, and you can take $4,000 of depreciation expense. So, you get $5,000 of cash in your pocket, and you only pay taxes on $1,000 of income ($5,000 less the $4,000 depreciation expense). 

So, in a nutshell, much of the income becomes “tax-free.” Now, of course, there’s no such thing as a free lunch, so the government does recapture some tax down the road. However, there are ways to kick the tax can perpetually down the road (such as using a 1031 exchange), so it is possible to continue to defer much of your taxable income. 

Real estate is one of the only asset classes that affords this opportunity. 

The Four Unfair Advantages of Investing in Real Estate:  A Summary

While numerous asset classes are vying for your attention, very few offer the benefits of real estate. Four of the key wealth-builders of real estate include:

  1. Cash Flow
  2. Mortgage Paydown
  3. Appreciation
  4. Tax Advantages

Very few other asset classes offer so many different ways to earn an investment return – and with tax benefits no less.

You can achieve these benefits by investing in real estate directly.  However, if you want to make it even easier, you can achieve many of the same advantages through investing in real estate passively through a platform like Fundrise, CrowdStreet, or RealtyMogul.

However, when it comes to real estate, it doesn’t matter how you get started investing. The most important thing is that you get started. See if real estate is a suitable investment for you and get started today! 

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