But isn’t investing in real estate risky? You’ve probably heard this before and it probably came from that friend who has an uncle that invested their life savings in real estate, only to somehow go broke in the process. The simple truth is that investing in things you don’t understand is inherently risky, be that real estate, crypto, or stocks. Education will be your best weapon for avoiding those bad investments and will help you identify the best opportunities.
While there are risks and rewards with investing in any type of asset, I would argue that smart real estate investing offers the most benefits for the least amount of risk when compared with other types of investments you could consider. The truth is that most wealthy people own real estate because of the many financial benefits. And while there are many more, here are my top 4 benefits of investing in real estate.
1. Real Estate Investments provide monthly cashflow
While cashflow is the most common benefit people think of when they think about real estate investing, it certainly isn’t the only one. Cashflow is the amount that is left over after you’ve collected rent from tenants and subtracted the mortgage and any other property expenses. This leftover cash is your main monthly “reward” for investing in real estate. While any smart real estate investment should have positive cashflow, it is very possible to buy real estate that has negative cashflow, and could actually cost you each month.
Cashflow is a necessary component of any quality real estate investment and is typically the first number investors look at when assessing a new opportunity. “Cash-on-cash” is the metric used to measure annual cashflow and is how much cash you actually have in your pocket at the end of the year based on your initial downpayment. So if you invested $100k into real estate and you receive $12k in cash by the end of the first year, this would be a 12% cash-on-cash return. This cashflow is the money you can use each month to pay your own bills and live your life. Once your monthly cashflow exceeds your personal monthly expenses, you are technically “financially free”. Cashflow is that “passive income” that many investors depend on each month and is a core benefit of investing in real estate.
2. Someone else is buying you more ownership in your property every month
Wouldn’t it be great if someone agreed to help you pay the bank their required interest payment each month and also agreed to purchase more of your investment property on your behalf each and every month? Well, that’s exactly what your tenant does when they pay rent and you turn around and pay the mortgage. The mortgage payment is made up of “Interest” and “Principle”, and your tenant is paying both. This means that they are paying the bank the required interest payment, but the rest is paying down the principle balance of the loan and therefore you own that much more of the property each month. As the principle balance is paid down, you own more of the property over time and this value adds up to a significant amount over time and will come back to you when you sell or refinance the property in the future. Over time, principle pay-down equates to a very meaningful part of how real estate investors earn higher overall returns than can be offered by other investments.
3. The government “pays” you to invest in real estate
This benefit is often overlooked, but one of the most important. Simply put, the government wants you to invest in real estate and it says so in the tax code. The tax rules state that you can “depreciate” your real estate investment over time, which means that you can deduct a portion of the value of your investment property each year on your taxes. This deduction can offset the cashflow you receive from the property and lower and sometimes even eliminate the taxable income from the property each year. This reduction in taxable income essentially increases how much you earn each year. Pretty neat, huh? Well it’s even better than you think, because while you are depreciating the property over time, the actual market value of your property is still growing. Real estate is the only asset you can invest in that grows in value while you at the same time are reducing its value on your taxes over time. There is no other asset type you can invest in that offers this same benefit. Depreciation becomes a very meaningful component in the overall return on your real estate investment.
4. Real estate grows in value over time
Most real estate grows in value over time, meaning you would be able to sell it at some time in the future for more than you bought it for. This is a broad statement, and there are exceptions to the rule. But in general, most real estate grows in value, given enough time. If you own a single family rental property, for example, it will typically appreciate 3-5% per year based on average national historical data. Certain parts of the country have appreciated much faster and some slower than this. But typically, you would see your rental home appreciate in value over time. If you own a commercial real estate investment property, like an apartment building or industrial property, the value of the building appreciates based on the NOI (Net Operating Income) and this is usually affected most by the rents that are charged to tenants. As rents grow, the NOI typically grows too and the value of the property appreciates accordingly. To sum it up, real estate investments are will most likely grow in value over time and this will increase your overall return on your initial investment.
Combine all 4 benefits
When you add up just these 4 benefits – Monthly cashflow, principle pay-down, property depreciation, and property appreciation – the decision to invest in real estate over other assets becomes very compelling. To refer back to the example above, if my first property I purchased provides a 12% cash-on-cash return (which would mean $12,000 back in my pocket each year if I invested $100,000 initially), that would be an excellent return on my invested capital even if I didn’t consider the other benefits. When adding up all the other benefits, my annual return increases into the 20%-30% range annually, meaning that I would be earning between $20k-$30k in “value” each year from my initial $100,000 investment. This type of annual return is difficult to ignore and beats out most any type of investment vehicle you could consider. And, for these 4 main reasons, most wealthy people invest in real estate as a primary part of their investment portfolio.
What do you think? We would love to hear from you and answer any questions about our investment strategy here at Coastland Partners. Join our mailing list here to learn about our upcoming passive net-leased investment opportunities.
James Kappen is a seasoned entrepreneur who has started, grown, and sold two software companies over the past decade and is now is focused on helping others replace their active income with passive income through real estate investing.
Find James on Linkedin, or reach him at james (at) coastlandpartners.com