Top 5 Advantages of Real Estate Investing

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Real Estate Investing Advantages For Building Wealth

"Ninety percent of all millionaires become so through owning real estate."-Andrew Carnegie

I've heard the above quote so many times, but I've never actually verified if billionaire Andrew Carnegie every actually uttered those words.

But I do believe those words to be more or less true. Real estate investing holds numerous advantages over other investable assets. Whether we're looking at the elite wealth holders of pre-depression or today, wealth can be largely attributed to owning real estate. There are more investment options available today than ever before with stocks, bonds, short & long term treasury bills, private equity, even cryptocurrencies. There's quite literally something for everyone.

In my opinion, real estate investment has a place in each and every investors' portfolio. The advantages of real estate investing seemingly far outweigh all other options. In combination with one another, the superiority of real estate investing can't be debated.

Top Five Advantages of Real Estate Investing

Control

One of the most obvious, yet overlooked, advantages is that real estate is a controllable asset. Simply put, control is defined as determining the behavior or supervise the running of something. Ok, maybe not simply put. We know control means you determine, or at least have significant input, in the final outcome. You, the investor, control what asset class you invest in. You control what geographical areas you invest in. You control how the property is managed. You control the tenant that occupies the property. You control expense management. You determine your price point. You determine the hold and exit strategies. Try telling the CEO of a publicly traded company that you are in charge of strategy. Or a hedge fund manager what assets or companies to invest in. Let me know how that turns out.

With real estate investing, you are in control of whether the investment succeeds or fails! You, then, are in control of your real estate investing wealth and future. No excuses to be found in real estate.

Still think that control isn't an enormous advantage. Ask the investors that bought into Enron (https://www.investopedia.com/updates/enron-scandal-summary/), Bernie Madoff (https://corporatefinanceinstitute.com/resources/capital-markets/bernie-madoff/), and FTX (https://www.nytimes.com/2022/11/10/technology/ftx-binance-crypto-explained.html). Those investors, including very large hedge funds and pension funds, made the decision to give up control. And they lost!

The Greek and Irish debt crises of 2009-2014 wiped out billions of dollars from stock and bond investors worldwide. Those investors didn't cause the crisis. Decades of overspending and borrowing combined with declining production and revenues caused the crisis. But the investors lost anyway.

Lesson: Control matters.

Appreciation

Appreciation is simply the increase of value of real estate or another asset over a period of time. Historically, real estate average appreciation of 6%-8% nationally each year. This average takes into account the peaks and valleys of the market over a longer period of time. It's important to note that the rate of appreciation is not equal across all markets across the country. Consider Miami, FL and Des Moines, IA. The rate of appreciation is considerably higher in Miami. However, the valleys are also likely steeper in every down turn. So, not only the increases but decreases as well should be factored into your strategy.

The appreciation of real estate may also be considered a hedge against inflation. Since the end of 2021, inflation has been an oft discussed topic given the trends of the last two years. Inflation is an erosion of value and purchasing power. That's why even though hourly wages have increased approximately 5% over the last twelve months individuals feel poorer. The rate of inflation has out paced the rate of wage gains. Again, real estate investing can help investors hedge against inflation. As inflation surges costs will increase. However, it's possible, if not likely, that rents will also increase. Thus cash flow will increase and offset the higher inflated costs. Lastly, periods of higher inflation tend to coincide with lower borrowing costs. These lower borrowing costs generally lead to higher real estate valuations since the pool of buyers will also increase.

When an asset has been purchased and held for long durations of time, the sale can result in large capital gains (more on this below) and profits. By large, I mean hundreds of thousands or millions of dollars. Given the rather unpredictable nature of stocks (mentioned above) and the current state of retirement programs such as Social Security and pension funds these gains could potentially fund a very comfortable retirement.

Cash Flow

How can you generate greater income without working harder, longer? What happens to you and your family if you lose your ability to work? Don't even get me started on the ever rising cost of education, energy, and medical care. Well unless the government hands out regular income like presents during the holidays, you must invest to generate life changing income.

"You do need to be an investor. Jobs rarely, if ever, lead to financial wealth."-Gary Keller (Keller Williams)

Cash flow is one of the desired outcomes of real estate investing. Income generated without enduring extra hours of labor at your employment. Don't be fooled, you're really only making your employer wealthy. That, generally, is not a path to independent wealth creation.

But this sounds like more work. That depends on your choice of investment strategy: Active vs Passive.

Active, is well, just what it sounds like. You are an active participant in most every aspect of the property. This is most common amongst single family & 2-4 unit properties. These properties aren't large enough on their own to warrant a property manager. So the owner is most likely self-managing. That means you are vetting tenants, performing improvements, collecting rents, etc...Passive investing is often called mailbox money. Whether office, industrial, multifamily, or net lease, commercial real estate investing offers more avenues for passive investing. This doesn't mean you are responsible for absolutely nothing. You may still have to negotiate long term leases or outsource capital improvements. But the daily allotment of time required is greatly reduced.

Regardless of your choice between active and passive investing, you determine your destiny!

Leverage

Leverage, borrowing, and Other People's Money (OPM) are ways of looking at real estate financing. Unlike any other investment class I can think of, real estate is the one investment where the average investor does not need the full amount in cash to invest.

Want to purchase $1,000,000 in stocks or mutual funds? Unless you are Warren Buffett or a CEO, you need to have the cash on hand.

However, if you want to purchase investment real estate for $1,000,000 you need only a fraction of that amount. Depending on the leverage choice you make (again control), you could need 10-30% down payment. Even with the increase in interest rates since December 2021 to now, the cost of borrowing remains low. Don't believe me. The Friday before leaving commercial banking in 2019, I funded a retail plaza purchase at 6.85%. Not much different than today.

If you prefer to not obtain bank financing, you can create a partnership or a syndication and pool your resources to make a purchase without any lender financing. In this case, you are leveraging relationships and OPM to invest. Other leverage options include CMBS, Fannie Mae, Freddie Mac, or private lenders.

After twenty years working with real estate investors, I can safely say: If you can find the real estate opportunity, the money to buy it can be found.

Tax Advantages

The tax advantages of real estate investing may just be the single largest benefit versus any other asset class. So let's dive right in!

Let me begin with the obligatory disclosure that I am not a licensed tax advisor or CPA in any state. This is not intended to be tax advice. Please consult your licensed tax advisor. Ok so that's out of the way.

Name for me an asset class other than real estate in which a seller can defer capital gains taxes. How about an asset class in which the cost to maintain the investment can be written off? How about tax deductions that didn't actually cost you anything out of pocket? Or where the deductions result in a tax loss while actually being profitable?

Generally speaking, operating costs of real estate investing such as maintenance, repairs, replacements such as appliances and windows, etc...can be deducted. The real estate taxes you pay to the county and the fees paid to a property manager fall into this category. Advertising expenses, utilities, property insurance, and even janitorial or security costs may be considered operating costs.

Did you finance the purchase of the property? The mortgage interest your paying is likely a deduction. So not only did you leverage your cash on hand to purchase the investment property, but now the interest is a potential deduction.

Now we get to my two favorite tax advantages: The ability to defer capital gain & depreciation.

Depreciation, unlike all the others above, is a non-cash deduction. Meaning it doesn't cost you anything out of pocket! Depreciation is the deduction of the acquisition price as well as improvements across the useful life of the property. So it's the gift that keeps on giving year after year.

Beyond the standard depreciation schedule available based on IRS guidelines, if the property or your portfolio is expansive enough you can venture into cost segregation. Essentially, cost segregation is based on the idea that the useful life across all components of a piece of real estate is not equal. Assume for a moment the property is brand new construction. What is the useful life of the roof, windows, interior portions such as cabinets, electrical wiring, flooring, etc...The useful life of each of these components is not equal to one another much less the 27.5 years the IRS depreciation is calculated on. Using cost segregation services you may be able to accelerate depreciation which in turn increases the depreciation deduction.

There are very specific rules that must be met in order to utilize depreciation. Use this link to the Internal Revenue Service to learn more. https://tinyurl.com/IRS-Depreciation

Lastly, real estate investing offers a seller the option to defer long term capital gains. This strategy is known as a 1031 Exchange. To be fair, I'm not going to get into all the details of a 1031 Exchange. That's a whole article unto itself (hmmm?!?). What this boils down to is upon the sale of real estate, usually investment or commercial, the seller can defer the long term capital gains tax owed by purchasing a like-kind property. As of today, the federal capital gains tax rate is 15% or 20%. States pile on as well with rates that range from 2.5%-13.3%. Not to mention capital gains taxes are calculated on your cost basis plus depreciation recapture. Imagine selling an investment property with a gain of $2,000,000 (post-calculations) in a higher capital gains tax state like New Jersey (10.75%). You could be writing a check for $615,000! A 1031 Exchange allows the seller to defer to a later date.

Try doing that with stocks or cryptocurrency!

While there are more investment options today than ever before, there is no doubt that real estate investing provides advantages that when combined are unmatched. From control of the asset, providing monthly cash flow, asset appreciation, the use of leverage, to the vast amount of available tax advantages real estate investing should be a vital part of every strategy. The work and education required may seem overwhelming. But people from varying walks of life and socioeconomic backgrounds utilize real estate investing to improve both their present and future. Real estate is an imperfect knowledge system. It is precisely this imperfection that allows investors to see opportunity where others do not.

The only question that remains is, will you take advantage of the opportunity in real estate investing?