The 4 Main Benefits of Real Estate
Benefits of Investing in Real Estate:
Is real estate a good investment? 20% to 25% of the world’s wealth is invested into real estate so it is one of the largest markets and should be considered as a diversifier in any investment portfolio
One key advantage of real estate values and incomes is that they go up over time from inflation. The real estate market has cycles, so buying at low price points provides extra returns, however, real estate investing for the long term should be buying when you can and do not try to time the market. In real estate income properties, you make a little bit each month that slowly builds up over time.
Benefits of Investing in Real Estate:
3. Tax Benefits
Benefit #1: Income
One of the main reasons to invest in real estate is that it produces income. Any property that produces income has the ability to cash flow positive with the appropriate amount of down payment. How much leverage you use as a buyer will determine how good the cash flow is. Sometimes for landlords in non-rent controlled areas they can raise the rents to market to quickly increase cash flow. Another way to raise rents is to remodel units when tenants move out to increase the rent for the next tenant. Income is the number one benefit of real estate. Since having a roof over your head is one of the most important things in life- landlords are usually the last bill to go unpaid which makes residential rentals some of the most resilient kind of real estate to downturns.
Benefit #2: Appreciation
Just like the price of milk in the grocery store goes up over time so does real estate. The force causing the rise in prices is inflation. Traditionally Real estate has been an excellent hedge against inflation. For Big City markets, or rapidly growing towns, owners can experience additional appreciation returns beyond inflation. For the long term expect 2% – 8% appreciation. The number one factor on appreciation is location, better areas appreciate at a faster rate then worse areas. Sometimes if you can catch a traditionally rough neighborhood in a transition (AKA gentrifying) you can also capture better returns than average. It is important to note that in the short term, real estate values move in both directions, so in a smaller time frame of 2-3 years it is possible to experience loss. That is because the short term is ruled by the real estate cycle, while the long term trend is controlled by inflation and demand.
Benefit #3 Property Tax Benefits
There are several tax benefits to real estate. There is now Go Zones and Special Enterprise Zones that can offer tax incentives.
The Homeowner’s Exemption.
For homeowners up to 250K of their capital gains tax is exempted for a single person, 500K for a married couple, for people who qualify. They must have owner-occupied the property for 2 of the past 5 years to claim this exemption. You can claim this exemption every 2 years.
This investor favored tax rule allows property owners to roll over their capital gains tax and depreciation recapture tax if they buy another property of “equal or greater value”.
Owners of investment property may take a small loss each year for depreciation which shelters either the properties income or your ordinary income. Depreciation boost cash flow for income properties.
In California, property taxes are governed by Proposition 13. This limits assessed values from increasing more than 2% each year which traditionally has been far exceeded by the appreciation of 3% or more. This offers long term owners significant savings.
Capital Gains Tax Rate
If you hold real estate longer than 1 year it is considered a “long term investment” which means you pay capital gains tax on those earnings which is signifantly less the income taxes. Capital gains can range from 20% to None and depends on your tax bracket.
Benefit #4: Leverage
Leverage is the borrowing power a lender will grant a borrower. In Real Estate the leverage can be very large and sometimes 0.00 with VA Loans or No downpayment loans (appeared in 2007- currently 3.5% is minium down payment with FHA Loan, that entire amount can be a gift, mandatory PMI for the life of the loan. Lenders will typically require 10%,20% down in residential, and 25% to 35% in a commercial with a positive debt coverage ratio.
With Leverage a buyer to can borrow 3 to 1, 4 to 1, and maybe as high as 5 to 1 for commercial and up to 5 or 6 for residential, that means with a $400,000 investment you can buy a 2M to 1.6M property. Appreciation occurs over the asset value so by putting in 400K of equity you are returning 4x appreciation. Leverage amplifies appreciation, it can also if used unwisely, can lose property to foreclosure so it should be used cautiously. My number one rule of real estate investing is break-even or cash flow postive.
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