There are many ways to build wealth and an investment in real estate can certainly be a great option. Financial professionals will speak of a maintaining a diversified portfolios, which often includes a real estate investment. Let’s take a look at some of the advantages of investing in real estate.
Rate of Return – Return is calculated on your investment.
Example: You purchase a home at $100,000 with a $20,000 downpayment and the real estate market appreciates 5%. In this scenario, you are making a cash on cash rate of return of 25% on your initial investment of $20,000. 5% of $100,000 is $5,000. $5,000 of $20,000 is 25%. This is called financial leverage.
Income – Real estate offers the opportunity for rental income (cash flow). This would be the rent that you collect monthly on your investment less any expenses. The income made on a real estate investment is often referred to as the capitalization rate. This is calculated by taking yearly gross income less the yearly expenses to determine net income. Net income is then divided by purchase price to give you the capitalization rate (cap rate). Go here for a definition and example.
Control – If your property is underperforming, you have a lot of control. You can increase cash flow by charging for parking or adding a washing and dryer and charging for laundry. You can also fire or change the property manager to decrease expenses.
Tax consequences – If you plan correctly, when you sell an investment home you can avoid capital gains by turning around and investing in another investment home. This process is called a 1031 exchange and there is no limit on the number of 1031 exchanges you process in a lifetime. In addition, the tax liability on the rental income is often kept light due to the depreciation write offs.
Government Support – Historically, the government will support the real estate market (compared to the stock market). Although, you should never count in this, it is something to note. The most current example of this is what occurred in 2008, when the stock market and real estate market crashed, a lot of aid was given to the housing market. It went even as far as an 8k stimulus to homebuyers who purchased a home in 2010.
Real estate is just one way you can build wealth. Like any investment, there are a number of advantages to this type of investment. If you are giving thought to adding real estate into your portfolio, contact Liz to run the numbers to see if it is a strong investment.
Liz works full-time as a Real Estate Agent with LUX. Denver.
