For many years, real estate investors have spoken of rental real estate as the “ideal” investment.
The word ideal can be an acronym for five key factors of real estate investing that have made it attractive as an investment alternative.
Let’s take a closer look at each key characteristic:
INCOME POTENTIAL
Where can you find an investment that not only pays for itself on a monthly basis, but also pays you in predictable and (for the most part) controllable installments, month in and month out?
You can invest in the stock market and place your bets on the ability of the blue chips (or the more risky issues) to give you a regular return. But that can be a roller coaster ride. And with stocks and bonds you relinquish control over your funds totally, except for going into the market and exiting an investment.
In contrast, when you have income-generating property, together with the management controls you need, that income stream just keeps on flowing. My friend Bill Cook calls this his “mailbox money.”
DEPRECIATION (and other tax benefits)
Real estate is one of the few investments remaining that offer a true opportunity for a tax shelter.
In a nutshell, you can break even annually on a cash basis, take a paper loss for depreciation, then apply that loss against regular earned income, thus lowering your liability for income taxes.
There are specific limits on how much sheltering is allowed, and at certain income levels the sheltering feature disappears altogether. But investors who materially participate in their investments may gain an exclusion from those limits.
In addition to tax sheltering, rental income is typically not subject to social security taxes, boosting its value to the investor. And let’s not forget that when one sells real estate, it is often considered a “long term capital gain,” which is currently taxed at a rate of 20 percent for federal and 6 percent state in Georgia.
Tax laws change. Be sure to check current laws and regulations with your income tax professional.
EQUITY BUILDUP
When your tenants make their rent payments, part of that income goes to pay interest on the loan, and part goes to reduce the balance you owe. This unique feature means that every payment causes your equity position in the property to improve. As the debt is serviced, your loan balance declines, and your net worth increases.
This simple characteristic makes real estate unique. You make money while you sleep because someone else is paying down your loan balance in exchange for the privilege of using your property.
APPRECIATION
Appreciation is the tendency of real property to increase in value over time.
For years, investors relied on inflation to boost values. But that inflation began to melt away when the Great Recession hit real estate and hit hard.
Yes, we are seeing a recovery of values today, but it’s clear we can’t count on inflation going forward.
However, there are a variety of other ways we can boost property values even if we have no inflation. For example, by hosting a neighborhood “Fix Up Day,” we can encourage neighbors to remove eyesores and pay more attention to appearance. Such actions help all home values in all areas.
LEVERAGE
I define “leverage” as the ability of a small amount of cash to control a large investment. It means, simply put, that you can control an entire piece of real estate and benefit from its full range of benefits, even if you don’t pay for it all at once.
By contrast, try buying stocks and bonds with nothing down. Try starting up a franchise with nothing down. Try opening up a retail store with nothing down. Real estate is one of the few remaining opportunities in which “the little guy” can make it big without a fortune to get started.
These five features - income, depreciation and tax benefits, equity build-up, appreciation, and leverage - make real estate still one of the most attractive opportunities for the average American.
Native Atlantan John Adams is a real estate broker, investor, and author. He answers real estate questions every Sunday at 11:00 a.m. on WGKA-am(920). He welcomes your questions and comments at Money99.com, where you will find an expanded version of this column.
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