I want to summarize what I view as the five advantages of owning real estate and how real estate differs from other investment assets. If you guys don’t know me, I’m a Realtor and real estate investor in the Charleston, South Carolina. Real estate has changed the trajectory of my life and my goal is to help others down that same trajectory.
The first advantage of owning real estate is this concept called “buying equity”. This is a concept I preach to all my investor clients or even my clients who want to start down the real estate investing journey with a primary home purchase. Another way to say this is to buy a home under market value or appraised value. As soon as you do that, you have essentially increased your net worth by whatever the difference between purchase price and appraised value is.
Take for instance this example. You find a home that needs repairs. Let’s say the after repair value, or ARV for short, is 300k. But you’re able to buy it for 230k, and then put another 30 thousand into the home in the form of repairs. You’ve invested 260k, but now the home is worth 300k. So that 40k difference is essentially equity that you bought. I say it again and again with my investors – the crux of real estate investing is finding the right deal.
The margins MUST work for your investment strategy. Buying a turnkey home at market value is not real estate investing in my book – that’s just parking money. And that money could be better suited in a different investment asset. Buying equity is a great way to increase your net worth and is better suited for the long-term approach that real estate investment is meant to be.
The second advantage of owning real estate is principal paydown. Over time, you or your tenants will be paying down the principal of your loan. Now depending on where you are at on the amortization schedule, this could be significant, or it could be insignificant at first. Either way, each month you make your payment, your net worth is increasing, even if you can’t necessarily access that equity immediately. But let that add up over a period of five, ten, or thirty years and all of the sudden you have some serious equity in your investments.
Now the third advantage of owning real estate is the tax advantages of doing so. Now I am not a tax advisor or CPA, so you’ll need to consult with your accountant for your situation and make sure everything is applicable to you. But there is a reason why so many millionaires and billionaires own real estate.
When I am giving real estate seminars, I describe it like this: the government recognizes it cannot do two things. First, it cannot create jobs for everyone and second, it cannot create housing for everyone. It relies on private market forces to do so, and to stimulate those forces, it writes the tax code to make it very advantageous to be a property owner or business owner. But we’re talking about real estate – what are the tax advantages of real estate?
Well, if you just own your own primary residence, then you can take the interest you pay each year and offset your active income. Instead of taking the standard deduction, you might find that it’s more advantageous to take an itemized deduction with your interest expense, especially in this era of elevated rates. Again, talk to your CPA about your particular situation. But primary residence benefits are boring – the real fun of the tax code is in investment properties.
There are so many ways to shelter passive income, and sometimes active income in certain scenarios, through real estate investing. For instance, if you do it right, depreciation plus interest expense + operating expenses of your investments should typically offset any income you make through your passive investments. In other words, it is very easy to show the IRS you’re operating at a loss when in fact you’re operating at a profit. What happens when you want to sell the property and take a capital gain? You can actually defer those gains until you die through Internal Revenue Code Section 1031, or a 1031 exchange for short. When you die, your heirs receive the step-up basis of the real estate up to a limit, so they don’t have to pay taxes either. In other words, if done right, you can make it so you never pay taxes on your investment real estate, from the money you receive from tenants to the gains you receive when you sell the property. All you need to do is buy another like kind property, and over decades people can do this to step up from single family homes to multi family to apartment complexes to multiple commercial assets and investments – all without ever paying capital gains tax if done correctly. Pretty cool, right?
Now, let me stop right here and get something off my chest. There’s a lot of people in this country that will disagree with this mindset. They get angry at this – that the rich “don’t pay their fair share” et cetera. And I get that. But there is a system in place. We have to play within the system. We didn’t get to write the system, and we have no control over it. Getting angry at the system does not change anything, and the system isn’t changing. So I feel like a better idea is directing our energy to make the system work FOR us. Create a better life for you and the people closest to you. And like all investments, you take a risk and reap a reward. The difference between real estate and other investment assets is that there are multiple ways to make money in real estate – and the money you do make typically isn’t taxed when done correctly.
Which leads us into the fourth advantage of real estate: cash flow. The idea is that tenants of your investment properties will pay for the monthly debt obligation, like your mortgage payment or some other note, and then you’re able to pocket some leftover cash. It’s true passive income, right? Well, maybe, but usually not. Ask any real estate investor and most will tell you it’s not truly passive. Typically the cash flow you do get will not be significant enough to be life changing. I know some very seasoned investors who target properties that might cash flow only a couple hundred dollars per month. For cash flow from your rental properties to be truly life changing, you usually need quite a few doors. Don’t quit your job after you buy your first rental because you think you now have passive income.
Personally, I set aside all of my cash flow from my own investments to just take care of repairs and other expenses as they come up. Now there are some great ways to increase the cash flow from your investments – I even made a video on it – but for now we’ll leave cash flow at that. It’s nice, but until you start getting a large portfolio, it’s nothing much really.
Let me caveat by saying that house hacking cash flow is significant. If you’re able to rent out a couple of rooms in your house, or the other side of a duplex that you live in, then you’ll pocket thousands if not tens of thousands each year. The great thing is that just offsets your mortgage payment that you would have otherwise been paying in full. Finally, let me leave you with one last thought. That is, all investment properties should cash flow – you never should have an investment property that’s losing money on a monthly or annual basis – I just want you to recognize that it’s not going to be significant.
Now we’re left with the last advantage of owning real estate – and that is, market appreciation. Over a thirteen-year period, there has never been a time in US history where real estate has lost value. It has always gone up in the long term, which is why its described as a long-term investment. It’s not a get rich quick scheme, and plenty of people have lost tons of money through speculative investments. That’s not what I’m talking about here.
Now after the US came off the gold standard and the Federal Reserve started playing with monetary policy, real estate prices really took off. It is possible that there is a further upward trajectory in prices with the insane amount of quantitative easing since 2008 and especially during the COVID-19 pandemic. In other words, there’s a lot more money in circulation right now than ever before, and that money needs to go somewhere. Sometimes, depending on the market cycle we’re in, it’s only inflationary pressure that drives real estate prices up. That could be as low as 2 to 3 percent that we saw year over year in last decade, or as high as 9% that we saw in the pandemic economy. Other factors besides inflation affect real estate prices, sure, but the great thing about real estate prices is that it tends to follow the inflation trend line. There’s going to be periods of growth and periods of contraction.
But you cannot just look at real estate on a national level. It differs from market to market, and even within markets themselves. Areas with rapid population growth and wage growth tend to appreciate faster than others where those demographic trends are not present. Ask anyone who has been around real estate for 10, 20, 30, or 40 years. True wealth in real estate is not made through buying equity, though it certainly starts you on the right foot. It’s not through principal paydown either, though it can over a long period of time. The tax benefits keep money in your pocket and cash flow won’t make anyone rich. No, ask experienced investors and they’ll tell you that true wealth in real estate is made through appreciation.
