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Benefits

Benefits of Real Estate Investing

Diversification

“Don’t put all your eggs in one basket.”  We’ve all heard this famous idiom before and in the investment world it’s often misunderstood.  Most financial planners would recommend diversifying your stocks into small companies, large companies, international companies, and even across different sectors, funds, etc.  However, the problem with this is that all of your investments are still within the same asset class and tied to the stock market.  True diversification is investing in different asset classes that are de-correlated such as currency, stocks, bonds, businesses, commodities and real estate.

Diversifying not just among different stocks, but among different assets, is how an investor can truly mitigate risk. Even with a well-diversified stock portfolio, an individual is still exposed to market risk (or systematic risk as finance professors like to call it), which cannot be diversified away by adding additional stocks.

Basically, diversification among asset classes works by spreading your investments among various assets with low correlation to each other. This allows you to reduce volatility in your portfolio, because different assets move up and down in price at different times and at different rates. Thus, having a portfolio diversified among different assets creates more consistency and improves overall portfolio performance. – Investopedia.com

A good way to tell if you’re diversified is to see how your net worth is allocated among the different asset classes.  If you have a majority of your investments tied to the stock market it may be time to buy a rental home, which has a very low correlation with the stock market.

Leverage

leverageIf you invest $50,000 in a down payment for a $200,000 home and it’s market value appreciates 5%, you would earn $10,000.  However, your initial investment is only $50,000 so your real rate of return is 20%!  That’s the power of leverage.  Try asking your lender if you can borrow $50,000 to buy $200,000 worth of stocks and you probably won’t get very far.  If you invest the same $50,000 into stocks, your 5% increase is only a mere $2500.

If you purchase at the right price, in the right market, with at least a 25% down payment that most lenders are requiring for investments, your rental home should be cash flow positive every year.  That is because you’re also leveraging the assets of the tenant who is paying off your mortgage every month.  One of the most effective ways to make $1 Million is to accumulate $1 Million in real estate debt and have somebody else pay it off for you!  Real estate rents also rise with inflation, helping owners to maintain their real returns.  To summarize, you can leverage the bank to help you make the purchase and then leverage renters to help you pay it off!

Tangibility

Real Estate is something you can see, touch and stand on.  The land never depreciates and the home, even if destroyed by fire, can always be insured.  If you’ve ever seen your stock market shares plummet to zero, you can appreciate the tangibility factor of real estate.  Furthermore, because it is tangible, the investor can have a direct impact on improving the market value by making smart improvements and updates to the home.  This gives the investor a greater degree of control over the performance of a real estate investment over other types.

Tax Benefits

You can write off all the standard operating expenses that are related to owning rental property and also depreciate the cost of the structure over a 27.5 year schedule.  If you want to sell an investment home, you can also defer the taxes on your gains by conducting a 1031 Exchange.  Talk to your accountant and local 1031 Exchange company for more details.  The bottom line here is that there are tax advantages unique to the real estate investor that are not available for other asset classes.

 

NEXT:  Strategies for Real Estate Investing