As an investment, real estate is the oldest investment known to man. In the early days of Greece, Plato and Aristotle discussed the merits and liabilities of owning land. Since those early historical days, owning real estate has been a staple of securing wealth.
One difference of real estate investment is that you don’t have to have all the money in your pocket to buy what you want. As an example, say you have your eye on a house that costs $800,000. You have $200,000 you saved over a three-year period. With a good income and credit rating, you go to a bank and get a mortgage for $600,000. Instead of taking nine more years to save up the balance that you need for the house; you now own it in a matter of months. There aren’t too many investments that give you that flexibility to immediately get more value than what you pay for it.
Outside of owning your home, investing in real estate means making money from tangible property or producing a cash flow linked to tangible property. In its purest form, the investor is a landlord. He or she owns the land and building(s). That person finds someone who wants the property and charges them rent for it. There is a psychological comfort for many investors to owning property like this. They can go to the property and see what they own. They have a certain degree of control in charging what they want for the property. Real estate becomes a very active investment, as an owner can be vigorously involved in negotiations as much as they want to.
There is a misconception with real estate purchases; namely, that the value of the property will always increase. As recently as eight years ago (and there are many such down cycles in the past), the real estate market went stagnant in many locations throughout the United States and absolutely tanked in certain areas. Many people were (still are) underwater, meaning their property was worth less than what they owed on it.
Another component of this investment is that buying and selling real estate occurs at very infrequent intervals with very low liquidity. Ten and twenty years may pass before a home or building changes hands. For the most part, there is going to be a change in price from one sale to the next. However, if you look at the rise in value of a building, you will usually find that the price increase matches the rate of inflation for the time it was off the market.
There are certain tax advantages when investing in a property. You do have depreciation working for you. Even if the value appreciates, the government allows owners a tax deduction of their property over its life span. Besides the depreciation, investors can usually claim the interest portion of their monthly mortgage payment as a tax deduction.
One of the biggest detriments to success in real estate investment is paying too much for the properties you acquire. Be very careful in analyzing the properties you are thinking about buying. Whether you are looking to turn it around quickly to sell, or plan to receive long-term rents, thoroughly investigate the location, local real estate trends, and any other factors that could be the difference between success and failure.
For an individual who would still like to invest in real estate but avoid the responsibilities of actually being a landlord, he or she can buy into a real estate investment trust (REIT). REITs have a unique tax structure and became an alternative real estate investment in the 1960’s. They came about to urge smaller investors to invest in real estate projects that they normally could not afford, such as building malls or hotels.
A REIT is similar to a mutual fund in the way it works. You are investing in a portfolio of properties rather than a single building. You buy shares of a REIT, and your gain or loss depends on the performance of those properties as a whole. If one or two of the properties underperform, the hope is the remainder of the portfolio more than makes up for them. It spreads out the risk to the investor’s dollar. In addition to the diversity, another important advantage of REITs is their liquidity. Unlike actual real estate, you can quickly and easily sell your REIT shares.
Here are some final tips on investing in real estate:
- If you buy real estate for rental purposes, then make sure you do not own it personally, but inside an LLC to limit your liability from lawsuits related to rental property.
- If you are buying your primary home, then it is good idea to purchase with a 30-year mortgage even though you are planning to pay off the mortgage in 10 to 15 years, as you would be able to take higher income tax deductions.
- Combine real estate with life insurance investment for solid tax planning as real estate is good for income tax, but not so efficient when it comes to the estate tax.