Why Invest in Real Estate?
“Ninety percent of all millionaires become so through owning real estate.”
~Andrew Carnegie
To understand the power of real estate investing, you have to first understand the ‘Why’ of real estate. It is the ‘Why’ that will provide you the motivation and the energy to invest in real estate. Once you are convinced that real estate is one of the best vehicles of wealth creation, understanding the ‘How’ becomes easy.
“Real estate is an imperishable asset, ever increasing in value. It is the most solid security that human ingenuity has devised. It is the basis of all security and about the only indestructible security.”
~Russell Sage
Most people who lack an understanding of real estate will tell you that investing in shares gives you better returns than those that come from real estate. There are others who say that renting is cheaper than buying your own house. You have to understand how real estate compares with other investment avenues such as savings account, shares/stocks, commodities, and businesses.
Rate of Return
Return on investment (ROI) is definitely one of the most important criterion you should consider whilst making an investment decision. However, simplistic calculations based on yields can be very misleading.
Yield, by definition, is the ratio of annual income generated by the investment divided by the dollar amount of investment.
Rate of return should be considered after taking into account the risk involved: is the investment is inflation adjusted? Is there any capital growth on the principal invested? Does the investment provide tax benefits and is it possible to leverage your money to get higher returns?
Real estate investments – as compared to bank deposits – are definitely superior in terms of yield and capital appreciation. Savings in banks do not provide a hedge against inflation and your money depreciates in value over a period of time.
Shares and stocks are perceived to have higher returns than property and provide hedge against inflation, but they are pale in comparison to real estate when you take into account the leveraging power of real estate investing and tax advantages of property. It is possible to buy properties by using Other People’s Money (OPM) with returns that are 20–100 percent, or more per annum.
Financial Leverage
No one has ever become rich without applying the power of leverage—as stated in an earlier commandment.
Financial leverage in the investment world comes from the use of OPM or Other People’s Money. In real estate investing, we buy property on a 10% down payment and yet we control 100% of real estate.
For example, let us say we buy a property of $100,000 on $10,000 down payment. Let us assume that the rent from the property covers the mortgage payments and the out goings. If the price of property moves up by 10% over the year, the market value will increase to $110,000. This means that we would have made a profit of $10,000 on our investment of $10,000, which is a 100% return on investment and was made possible only because of the power of leverage.
Our return on investment would have been infinite had we bought the property with no down payment. This kind of financial leverage is only possible if you invest in real estate. But before you rush to buy your property with no money down, you must understand how leverage works. There is no greater leverage in life than the leverage of knowledge.
It is extremely difficult to finance other types of investments such as stock and businesses because funding is always an issue. Banks love property because of the low risk and capital appreciation associated with real estate.
Leverage can be used for quick wealth creation. If you know how to use leverage, you do not need large amounts of initial capital to start your real estate investment portfolio.
Buy Below Market Value
You must have heard the saying: “you make money when you buy,” and not at the time of selling. Is it possible to buy stocks or diamonds, commodity or gold below value? When you buy $100,000 worth of stock, you pay $100,000 in cash.
Investing in real estate after gaining a bit of knowledge, you can buy properties that are 10 or 20 percent, or even more below market value. There are many reasons why people sell their properties below value. You can amass great wealth by simply buying property below market value.
Increase Value of Investment
Can you increase the value of your stock or bank deposit by tinkering with it? There is simply no mechanism by which you can increase the value of your stock or any other investment because you do not control them. However, you can greatly increase the market value of your investment property by spending a small amount of money on making cosmetic changes or applying for a change in the use of property.
Investment Risk
Banks are perceived to have the least risk when compared to other investments but of late this confidence has been shattered due to the high rate of failure of banks.
Stocks carry a much higher risk because their values fluctuate on a minute to minute basis. Stocks also do not go up in value, and business disasters – like Enron – can have a nasty effect on your stock market wealth plan.
Investing in businesses can be very profitable if you know what you are doing. The failure rate of new start-up businesses is around 80%. In business, you invest in people and ideas which are usually not as solid as bricks and mortars.
Property, on the other hand, goes up in value slowly and steadily. This is proven by the record of past 300 hundred years when property values have consistently doubled every 8 to 12 years. In the market crash of 2008-2009, when the stocks nosedived to 50–80% of their value and wiped out the fortunes of millions of people—real estate prices went down by 5-30% of their value.
If you wish to understand risks, then just check what banks are willing to lend their money for – are they willing to loan money to buy paintings, antiques, diamonds, mutual funds, CDs, commodities, stocks & businesses? If so, what level of funding is available?
For properties, banks will easily lend to 70-90% and in some cases, even 100% of the value. Banks are the most risk adverse institutions and if they are willing to invest in real estate up to 100% of value, then they consider the investment risk to be extremely low when compared to other investments. You should take your cue from banks.
Control over Investment
When you invest in stocks, you have no control over your investment until and unless you have the controlling shares in a company. You can hand over your money to a fund manager but you still do not have any control, and are at mercy of the competence or incompetence of the fund manager.
Shakespeare rightly said, “Fool and his money are soon parted.” There are many Madoffs in this world waiting to rip you off your hard earned money.
Invest in real estate and you have full control over your assets. You are not at someone else’s mercy—you control the shots and have peace of mind.
Real Estate Investing is forgiving to Mistakes
In every investment decision you make, there are chances of making mistakes. No one has a crystal ball that can predict the future. When compared to other vehicles of investment, real estate is very forgiving to mistakes. Property prices tend to increase relatively smoothly and consistently. Real estate investment is the simplest, most reliable and most consistent vehicle of wealth creation. You can convert even a little bit of financial IQ into lot of cold hard cash. And above all, you have total control over your investment and assets.
Real Estate Offers Exceptional Tax Advantages
The biggest expense in your lifetime is the taxes you pay to the government: I must repeat once again! You will find that you pay more than 50% of your earnings to the government in the form of taxes. Most people are not even aware of how much they pay because some taxes are indirect taxes.
The rich are rich because they pay little or no taxes. If you are smart, you can do the same and fund your lifestyle and investments by saving on the taxes.
Real estate tax laws differ from one country to another. However, universally applied tax principles throughout the world hugely favor those who invest in properties. As opposed to other investments, you can run your property investment as a business and claim back depreciation, interest payments and other expenses as a part of your business.
It is sufficient to say that tax refunds from real estate investments provide you with additional cash flow to buy more investment properties and create residual income.
In case of stocks and shares, you have very little or no tax benefits and have to pay tax on interest and dividends received. Governments at times give incentives when you invest in certain types of infrastructure bonds or mutual funds. These normally offer very low returns and many times do not justify investing in these instruments even after taking tax breaks on offer; this unique advantage makes investing in real estate very attractive when compared to other investment opportunities.
Monitoring Your Investment
Unlike other investments, you do not have to monitor your real estate investment from moment to moment like a hawk—there is peace of mind.
The whole point of investing is to create multiple streams of residual income that can fund your lifestyle. There is no fun if you have to monitor your investment on an hourly or daily basis, which is the case with investments in stocks, foreign currency or commodities, the values of which change constantly. You have to watch these investments like a hawk if you have to succeed.
Property prices tend to move very slowly, smoothly and constantly with a minimum amount of fluctuations. This makes it very easy to monitor your real estate investment.
Invest in real estate and you will have the most passive and hands-free of all available investments opportunities.
Fluctuations to National Average
The price of each stock fluctuates on its own merit and there are numerous imponderable variables that dictate the price of a stock. It is therefore very difficult to monitor every stock in your portfolio because each one is very different from the other. It requires a genius of Warren Buffet’s caliber to beat the market averages consistently. Even expert fund managers struggle to keep up with market averages.
In the case of real estate, fluctuations of any one property relative to the national average are very low. It requires very little expertise to beat the national average for property and increase your return on investment.
Real Estate is, without doubt, the safest way to create long-term residual income.
Many people buy property with the hope of creating passive cash flow in hopes of retiring peacefully. Sometimes, they get disappointed because their properties do not generate adequate cash flow to retire even after they have bought 5 to 10 properties. The problem arises because they buy negatively geared properties that are highly leveraged. In order to create residual income, you have to buy cash flow properties and reduce your mortgage over a period of time.
Properties take time to create residual income. As time goes by the prices and rents go up: these two factors will increase your equity and cash flow. You can also convert equity into cash flow to create residual income.
Also do not confuse property flipping, forex, commodity or share trading as instruments for creating residual income. These are nothing but full-time jobs with little or no chance of building an asset or generating residual cash flow. These activities are nothing but skill-based jobs in which you have to work full-time to make money. They may be great strategies for generating cash flow but cannot be termed as investments for creating residual income.
I hope you are convinced by now that real estate is the perhaps the best vehicle to generate long-term passive income – it is solid and time tested.