At one point or another, most people have heard how real estate is a powerful asset to own.
And it’s true, real estate is an asset with many unique benefits. However, it’s important to note that real estate can also have risks, such as market downturns or property devaluation.
But I often see how a lot of people jump into real estate without knowing much about it.
Whether you currently own a property or plan on owning a property at some point, here are 5 potential benefits that you should be aware of:
Generating Rental Income
Investing in real estate provides the opportunity to generate a steady income stream through renting out your property, offering a reliable cash flow that can supplement your other income. Whether you’re renting your property as a short-term rental (i.e. Airbnb, VRBO) or a long-term rental (renting it out for multiple months/years at a time), you can generate an additional stream of income through doing so.
Rental income can help offset the mortgage payment on your property and other expenses associated with it. And even if you aren’t earning a large profit from rental income, you still own an asset that will hopefully appreciate in value over time. However, rental properties may face vacancy periods where no rental income is coming in, creating cash flow challenges.
Tax Benefits
Real estate investors can take advantage of various tax deductions and benefits, such as mortgage interest, property taxes, and depreciation, which can reduce taxable income. Depreciation, specifically, is a unique benefit to an asset like real estate. It is the wear and tear of the property over a period that the IRS allows investors to deduct from their taxable income. Items like depreciation can allow you to show a loss on paper while still generating profit.
Depending on the size of your investment property, it could make sense to conduct a cost segregation study. A cost segregation study potentially lets you accelerate the depreciation of your property in the early years by depreciating specific pieces of property around the real estate at a faster rate, and receiving a larger tax deduction upfront. This can be a beneficial tool, but there are many considerations, and you should speak with your tax advisor to determine the tax benefits that make sense for your situation. Keep in mind that tax laws can change, and overestimating deductions could lead to costly audits or penalties.
Leverage
Real estate allows you to use leverage, meaning you can purchase properties with a fraction of the cost upfront through financing the purchase. Leverage can amplify your return on investment. For example, let’s say you purchase a $200,000 property and put 20% down (or $40,000), and finance the rest through a $160,000 mortgage. Let’s say you rent the property at $12,000 income per year, and the property appreciates $10,000 in value that year.
In this case, not including any expenses, your ROI would be ($12,000 rental income + $10,000 appreciation) / $40,000 down payment, or 55%.
In this scenario, only $40,000 was invested because of the use of leverage. But beware, leverage not only amplifies returns, but it also increases risk since you are taking out a loan. It’s a double-edged sword that must be used with caution. On the downside, if the market falls or rental income decreases, you still have to repay the loan, which can lead to financial stress.
Inflation Hedge/Value Appreciation
Real estate often acts as a hedge against inflation, as property values and rental income tend to increase over time, preserving and potentially growing your wealth. Rental rates tend to increase in inflationary periods, ensuring that your income from real estate keeps pace with the rising cost of living. As mentioned, real estate can be a helpful income supplement.
However, real estate is not guaranteed to appreciate in value, and downturns in the market could result in a loss of value, particularly in the short term.
Physical Asset
Unlike stocks or bonds, real estate is a tangible, physical asset that you can see and manage directly, providing a sense of security and stability in your investment portfolio. From an emotional standpoint, many people enjoy having an asset they can see as opposed to some other asset classes that exist.
However, as a physical asset, real estate is also illiquid, meaning it can take time and effort to sell if you need quick access to cash.
As you can see, real estate indeed has several advantages. It can be a valuable asset to diversify your overall investment portfolio, but of course, has it’s limitations as well.
You can invest in it directly through purchasing properties yourself, and also indirectly through avenues such as real estate investment trusts (REITs) which allow you to purchase a fund that manages/invests in real estate for you.
Make sure to speak with your financial and tax professional before making decisions around real estate as an investment in your portfolio.
This article is for general information only and is not intended to provide specific advice or recommendations for any individual. You should consult a financial professional, tax professional, and/or attorney to discuss your specific situation.
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