Recap, Next Steps, Cheat Sheet
Note: this is Chapter 6 of an entire guide on Why Real Estate Investing?
We've covered a lot together. Below you'll find the key takeaways. Plus, you can download this cheat sheet for this entire guide.
Chapter 1: Benefits of Investing In Real Estate
Rental real estate offers a number of benefits: immediate income (and cash flow if done properly), equity growth, appreciation, diversification, leverage, and low volatility.
Income comes from placing a tenant in your property. Typically, investors aim for 1% of the purchase in rent (e.g. "The 1% Rule) to properly cash flow a property. A $150,000 home rented at $1,500 per month can cash flow over $600 with a low downpayment of $30,000.
Equity growth grows your stake in your home over time. Part of rental payments go to pay the mortgage, which flows through to the equity you own in the home. With a 30-year loan, you'll own 100% equity in your home, allowing your home to cash flow the entire rental payment.
Appreciation allows your money to grow with leverage. Although you invest $30,000, you can earn money an average of 3% per year on your total $150,000 investment because of leverage. Depending on locale, some locations may appreciate faster than others.
Diversification allows you to reduce risk. Real estate is an "alternative asset" which moves your portfolio concentration away from only stocks and bonds.
Low volatility is offered by the illiquidity of real estate, which helps protect your investment portfolio.
Chapter 2: Why Not Stocks and Bonds?
As stocks and bonds are becoming more correlated due to the popularity of index investing using Exchange Traded Funds (ETFs) and Mutual Funds (MFs), which increases volatility.
Volatility is further compounded with the democratization of stock investing due to the massive increase of inexperienced investors in the market today.
Real estate is naturally correlated with the economy. As the economy does well, the demand for real estate increases and thus the price increases. This may further be compounded in certain locales (i.e. cities). This allows real estate to act as an inflation hedge.
Real estate trades on a private market offering low liquidity and it rewards more experienced investors. This is a double-edged sword as you may see it as an advantage or a disadvantage.
It's not to say not to invest in stocks and bonds. But real estate may be a huge part of an investment portfolio.
Chapter 3: Tax Advantages of Real Estate Investments
Real estate investments allow owners to save a lot of money on their taxes using deductions, depreciation, and 1031 exchanges.
The list of deductions is wide. We discussed some of the most common: loan costs, loan interest, property taxes, insurance premiums, maintenance and repairs, utilities, professional fees, travel and transportation, and office space. These directly add to your expense list and decrease your net profit/income.
Depreciation (a special type of deduction) allows you to expense the value of the structural component of your home. For single-family rentals, you depreciate the home over 27.5 years. This directly decreases your rental income and thus lower tax liability.
The 1031 Exchange or "like-kind exchange" allows you to defer capital gains taxes similar to the way a 401k allows you to defer income and capital gains taxes. There are rules associated with 1031 exchanges that are discussed more in-depth by our Financial Analyst, James Kuttner, in this article.
Chapter 4: How Long Do Real Estate Investments Last?
The short answer: it depends on you.
There are a number of parameters that you should consider like your starting age, your income stability, your risk preferences, and your liquidity requirements.
Your starting age is important as financial life events are generally associated with an age group. Younger investors have longer times for compounding, but older investors tend to have more upfront capital.
Your income stability and your risk preferences allow you to decide how much real estate you can properly purchase and manage without taking on significant risk.
Deciding your liquidity requirements will help you decide how much money you should set aside.
Chapter 5: Various Options to Invest In Real Estate
There are 4 primary types of real estate: residential, undeveloped land, commercial, and industrial. Typically, most individual investors are able to invest in residential and undeveloped land directly, but must do it indirectly through fund options for commercial and industrial real estate.
In residential real estate, you can flip homes, wholesale, manage long-term rentals, or manage short-term rentals all with varying ranges of capital and time requirements. In undeveloped land, there is significant speculation involved and it's more difficult to make money.
With commercial and industrial real estate, individual investors will usually invest in public REITs that trade on the stock market. Higher net worth individuals may seek out Private Equity or Private REITs that often outperform other investments in exchange for a higher asset management fee.
Next Steps
Decided to move forward on investing in real estate? More specifically, are you interested in long-term residential real estate investments?
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