If you’re trying to figure out how to make the best use of your cash, here are the 7 key advantages of real estate investments.
My experience has been that real estate is the most rational and attainable investment opportunity for a self-made investor; someone with a lot of energy and desire but not a lot of money. I have been able to isolate seven areas where in my opinion real estate holds advantages over all other investment vehicles, which is what makes it such an excellent opportunity. These advantages are:
- Real estate offers passive Cash Flow.
- Real estate benefits from built-in Appreciation, due to inflation.
- Real estate investment market is accessible due to Leverage and OPM (Other People’s Money).
- Real estate is an Inefficient Market, offering a skilled investor More Control over the investment returns
- Real estate offers Infinite Cash Flow Growth Potential
- Real estate is the most IRS friendly investment vehicle
- Real estate Education is Readily Available, although it can get expensive.
I will not attempt to cover each of these topics in full, since each one deserves its own article. Instead, I intend this as brief synopsis, enough to give you the rudimentary awareness around these issues. But, I will come back to many of these elements more in-depth in later articles.
1. Real estate offers passive cash flow
I chose real estate as the best investment vehicle for me because it offered the best solution to the problem that I was trying to solve in my life – insufficient income. I realized that since I was hitting dead ends trying to increase my earning potential in my primary field of music, I needed to develop an alternative source, or better yet multiple alternative sources of revenue. And since I felt that I was already working too hard for too little, this could not be another job. What I needed was Passive Cash Flow, the kind that did not involve my hands-on participation on a day to day basis. After a careful analysis of the available to me opportunities I settled on real estate as the best investment vehicle to generate cash flow.
I discovered the simple formula that has made fortunes small and large for people throughout history is simply this:
If you own a house which rents for $600/month, but it only costs $400/month to maintain, then you get to keep the difference.
From here, the only two questions are: How many of these houses will you need to own in order to achieve your financial goals? And how quickly can you buy them?
2. Real estate benefits from built-in appreciation due to scarcity and inflation
Real estate normally appreciates in price over the long term for two main reasons. One – there is only so much dry land on this planet. This makes dirt a finite commodity, and as such the laws of supply and demand stipulate that the price goes up over time. This principal is known in real estate as scarcity. Two – real estate value in America is generally expressed in dollars, which means that prices are, at least over the long term, tied to inflation. Remember – the less the value of each dollar, the more dollars it takes to buy anything, including real estate. Since the average annual inflation rate tracked by the CPI over many decades seems to run between 3% and 4%, meaning that the dollar looses on the average 3% – 4% of its’ value annually, real estate appreciates every year proportionally.
Obviously I do not have a crystal ball, and naturally there are times when real estate goes through a deflationary cycle, but over the long term the trajectory of real estate prices has been up. As a result, a property that was purchased for $35,000 in 1960 would have fetched two to tree times as much by 2010. Furthermore, an apartment that would have rented for $150 per month in 1972, was rented for $425 or more in 2000. Thus, income-producing real estate is a prodigious hedge against inflation both in terms of the buying power of the wealth stored within it and in terms of income protection.
3. Real estate investments are accessible and wise due to Leverage and OPM
Question: if you have $10,000 in cash, how much stock can you buy?
Answer: $10,000 worth of stock
Question: if you have $10,000 in cash, how much gold can you buy?
Answer: $10,000 worth of gold
Question: if you have $10,000 in cash, how much real estate can you buy?
Answer: $100,000 or more
Yes, you read that correctly. In the world of real estate leverage makes a dramatic impact on the cost of entry. You will need some money to contribute to the deal as down payment, but it doesn’t have to be much. Furthermore, most savvy investors try to borrow the down payment money, meaning that their investment becomes fully financed. Translation – you don’t need money to buy real estate.
Even for those of us who happen to have lots of money in the bank, I believe that real estate is the best investment vehicle because leverage allows us to control much larger asset base. For example, if you have $200,000 in your IRA, which is invested in paper assets like stocks and grows in value by 10% over a period of time, then your portfolio will have grown by $20,000. That’s pretty good. However, if you used this money to make a 20% down-payment on a million dollar apartment complex which grows in price by 10% over the same period of time, then you would realize $100,000 of value. In the first example, the return of $20,000 on an investment of $200,000 constitutes 10%. But a return of $100,000 on your investment of $200,000 in the second example constitutes a 50% return. And leverage is what makes this possible.
4. Real estate is an Inefficient Market, offering a skilled investor More Control over the returns
The Efficient Market Hypothesis is a theory that the price of a security at any given time reflects all of the available pertinent information. That is to say that at the moment you purchase the asset, the price that you pay reflects the true value of that asset. This theory has been around since around the 1960es , and while there may be appropriate application for this theory relative to paper assets such as stocks and bonds, it is completely inapplicable relative to real estate.
In fact, real estate is an inefficient market, in which prices are set solely by the meeting of the minds of the seller and the buyer; the two people, or entities, who make decisions based solely by their respective circumstances, and having very little if anything to do with the market at large. This makes value in real estate very much a moving target. Often enough, that property you’ve just bought for $100,000 could actually be worth $130,000, in which case you did good; it could also be worth $75,000, in which case you paid too much.
More importantly, the inefficiency of the real estate market allows you, the owner / investor to do things that would increase the value of real estate through management. Thus, often enough a skilled investor will negotiate a purchase price of $75,000 on a property that is reasonable worth $100,000. And within a short time and with $5,000 worth of management expense, this property can be worth $130,000, thus creating equity position for this investor of $50,000.
|End Value Purchase Price||$130,000|
Another way of looking at this scenario is that the total investment of $80,000 which produced $50,000 of equity for the investor is a 62% return. And if you are wondering, this type of a transaction is nothing out of ordinary. These types of returns are quite pedestrian in the world of real estate specifically because it is an inefficient market.
For example, several years ago I bought a small 2-bedroom house with an unfinished attic for $24,000. I spent $20,000 on the remodel which included converting the attic into a third bedroom. Upon completion of the remodel, which took just over one month, the house was appraised by the bank at $70,000. Thus my total investment of $44,000 produced equity in the amount of $26,000, which is 59%.
In other seminars I discuss in more detail how to benefit from inefficiencies of the real estate market. For now simply understand that a skillful real estate investor benefits dramatically from the inefficient nature of real estate market in ways that are structurally impossible in other markets.
5. Real estate offers Infinite Cash Flow Growth Potential
The income from real estate is systematic. Building a portfolio of real estate requires building systems for management of that portfolio. This means that while you, as the owner of the property, do have to manage these systems, you certainly do not have to be the one on the end of the lawn-mower trading dollars for hours. Picture a chess board; all 16 chess pieces work in harmony under the control of the chess master. It hardly matters how many units you have so long as you pay attention to the management systems.
This reality creates a circumstance where if you can have 1 rental unit, you can have 4; and if you can have 4, you can have 40, or more. Naturally, there are learning curves to be negotiated, but the cash flow potential is truly infinite!
Personally, I am not a very handy person. I can throw some paint on the wall, but that’s about it. Moreover, I decided early on that in order to accomplish my objectives, I will have to own a very large portfolio, which would be completely impossible if I needed to be the one mowing the grass and fixing leaky faucets. There just aren’t enough hours in a day, so instead I higher all of that out to people who can get the job done faster and better than I ever could. Sure, it costs money, but I plan on it; I loose a bit of cash flow, but I gain the ability to grow much larger than I could otherwise.
6. Real estate is the most IRS friendly investment vehicle
The burden of taxes can be one of the largest obstacles standing in the way of wealth accumulation. InAmericawe have a tiered tax system – the more money you earn the more taxes you pay. This reality tends to put a lot of folks at odds with the Internal Revenue Service. The rational being simply this – why should I pay more taxes than the next guy just because I happen to be smarter or more capable then he? Independence streak runs deep in America, and even though intentional avoidance of responsibilities relative to taxation is a federal offence, this rational leads some people to risk fines or even jail time in the name of tax savings.
I do not understand this thinking, and would like to offer a different perspective. I have come to realize that the tax code is how the government communicates with the citizens. We live in a democratic society in which the government can not arbitrarily tell the citizens what to do. That would be illegal. However, it is completely legal for the government to try to entice us to do what they want us to do, which the government accomplishes through our tax code. One example of this is that home owners get to write-off their taxes the interest that they pay on their mortgage. Why? Because our government wants as many people as possible to become home owners and this is how they entice us. Another example is that corporations pay income taxes on net-income, which is income after expenses, while individuals pay income taxes on gross income. This means that the effective tax rate ends-up being much more advantageous for corporations, which tells me that the government encourages formation of corporations. Why? Because in a capitalist society such as ours the corporations provide most of the jobs and therefore most of the income for millions of Americans; government simply can not afford to feed everyone.
The legal loopholes available to real estate investors are plentiful. This is because the government understands that they could not possibly provide shelters for everyone who needs them, and they encourage entrepreneurs to enter the game by allowing fabulous incentives relative to taxation. Some of these loopholes include the ability to write-off interest paid to the banks and depreciation of property, equipment, and fixtures. Furthermore, section 1031 of the internal revenue code even allows investors to postpone the payment of capital gains tax associated with the sale of real property.
Doing things that are illegal is not only stupid but totally unnecessary. The tax code contains plenty of legal ways to lower your tax burden. It is beyond me why anyone would want to break the law if it is so easy to follow the instructions outlined in the law itself. The only reason is because they simply don’t know. This is why it is prudent to be educated in the subject, at least to the extent that enables you are able to speak intelligently to a CPA. Personally, I prefer to remain on the right side of the law always!
7. Real estate Education is readily available, although it can get expensive
I have spent thousands of dollars over the years on my real estate education. This education is everywhere; it’s in the library – though by the time it gets to you it is often irrelevant; it is all over the internet – though you usually get $1 of usable information for every $100 spent; there are TV infomercials – you pay $69 for the teaser course only to discover that in order to get any useful information you’ve got to spend another $3,000 to $10,000.
I have had personal experience with all of the above, and I created www.justaskbenwhy.com for the purpose of combining the best of all worlds. Membership to Cash Flow Freedom University is affordable like a book, but packed full of relevant information while offering direct access to me!