REAL ESTATE INVESTING IS A POWERFUL WAY TO BUILD WEALTH OVER TIME
Investing in real estate has proven time and time again to be one of the best methods of building wealth over time. Not only has real estate historically shown dependable growth of property values, it has also been able to deliver consistent cash flow for those investors as well. At Arrived we believe that everyone should be able to access the same benefits from real estate investing.
Below are the top 8 reasons why somebody should consider investing in real estate as a category. This article is focused on analyzing general real estate investing, there are additional reasons why we have decided to focus on single family homes, you can learn more about those reasons here. We also have another article focused on discussing how investing in real estate compares to investing in Stocks, you can find that here.
Top reasons why you should consider investing in real estate:
Consistent Cash Flow
One of the top reasons why investors pick real estate is the consistency in its cash flow returns. With real estate investing you are receiving a rent payment that is not only consistent in timing but also in the amount. Therefore the income derived from real estate tends to be very predictable and something you can count on. Other asset classes like equities have strong returns, but those returns vary wildly from year to year and their growth tends to be through value appreciation versus cash dividends. Due to the benefits of consistency in real estate investing, many people rely on this asset class to build their passive income that helps them achieve financial independence.
Historically High Returns
Real Estate investing has historically delivered very strong returns over time. Not only do property values increase as demand for real estate outgrows available supply, but the property cash flows, availability of very low cost debt, and tax benefits all come together to accelerate the returns. If we compare the 10 year return profile of Stocks as tracked by the the S&P 500 with a Real Estate investment as tracked by the Vanguard Real Estate ETF Total Return fund, we can see that real estate investing outperformed the equities by 32.9% over that time period.
Earn Money Through Various Methods
Unlike other investments that just provide one outlet for profits, Real Estate offers multiple ways to make money from your investment. First is the cash flow from the property after considering expenses. Second comes through the appreciation of the property over time. Third are the tax benefits that result from depreciating the asset and lowering your taxable income. Fourth, in the event there is leverage on the property, as the mortgage is paid down the equity owned in the property increases. These four items come together to provide a well diversified and stable source of wealth creation over time.
Access to Low Cost Financing
Real estate is a unique asset because debt financing is common, encouraged, and cheap. Adding leverage to a deal, as it is called, allows investors to greatly amplify the returns of an investment over time. As a basic example let’s say you buy a home worth $100,000 and you only put down $20,000 (you are using 80% leverage). If that property increases 10% the next year to $110,000, then your investment is now worth $30,000, or a 50% year over year return. While there are other considerations like interest payments, rental income will typically cover these expenses.
The reason that financing is so beneficial in real estate is that the interest charged by the banks is so cheap. Let’s say you finance a property purchase with money loaned from the bank at 4% per year and the property is returning 10% per year, you are essentially making easy money off that spread. The reason why banks are able to charge such low interest rates on real estate financing is because real estate values have proven to rise very consistently over time and those assets serve as collateral for the debt. That results in a win win where investors get access to low cost debt to increase returns and banks make low risk loans that are profitable. Below you can see how average mortgage interest rates have stayed consistently low over time. You can also see the different rates per the different debt and investment instruments, home mortgages are incredibly low.
Diversification of Assets
If you’ve ever heard the cliche “don’t put all your eggs in one basket”, then you know about diversification. Diversification is the process of investing in different assets to reduce risk and generate more consistent returns. Investing in real estate allows you to reduce risks without negatively impacting your returns. In fact with many types of real estate investing, you can actually increase your total returns. There are two main components of diversification benefit that come with real estate investing:
- Just by adding real estate to a typical investment portfolio will reduce the risk by adding an asset that is not correlated with the other assets. This means that as other assets in your portfolio fall, real estate will not react in the same way. From 2008 to 2017, private real estate investments only correlated with the S&P 500 by 19%, compared to 79% correlation for public real estate. Real estate is less volatile than stocks and tends to have a low correlation with the public markets. While stocks rapidly swing up and down, real estate tends to consistently increase while producing income for its owner at the same time.
- The other diversification benefit comes from the fact that within real estate itself you can distribute your investments across different properties with unique tenants, different markets with unique city dynamics, or even different property types (housing, commercial, industrial..etc).
On average real estate has historically shown lower volatility than stocks and other investment asset classes. One reason is that since housing is a necessity and not a luxury expense (people always will need a place to live), while there are changes in overall demand for housing, those fluctuations are much less pronounced. Given that consistency over time, as an investor there is less of a need to try to time the market fluctuations. In the below chart you can see the annual returns for stocks (equities) compared to housing. While stocks have wild swings and long periods where the returns are low (1966-1982), you can see that housing returns are steady over time.
Generous Tax Benefits
One of the most powerful benefits from investing in real estate are the ample tax advantages available. These tax benefits allow real estate investors to defer or just plain minimize their tax obligations over time. Below are some of the main tax benefit drivers.
- Depreciation: The most unique tax advantage to real estate is depreciation and its ability to lower your taxable income. Each year, the physical structure of a home gets another year older. Roofs eventually need to be replaced and water heaters break. The IRS lets you count the cost of the house getting older each year to reduce your taxable income. Depreciation is incredible because it’s not an expense you actually pay. You NEVER get a depreciation bill in the mail, it’s just a “phantom expense”. Additionally depreciation lets you “double-dip” on the same expenses. You can deduct repairs and maintenance expenses to lower your taxable income. Then you can also use depreciation to lower your tax bill further.
- Long Term Capital Gains: Since real estate is almost always held for over a year, investors are able to secure the very attractive long term capital gains taxes. The relative illiquid nature of real estate actually plays into favor for tax minimization.
- REIT Benefits: The Tax Cuts and Jobs Act of 2017 added another major benefit for real estate. Dividends from REITs (such as Arrived Homes) are eligible for a 20% deduction on all income. This means that if you earned $1,000 in taxable income from a REIT, you would be taxed as if you only made $800. This deduction isn’t unique to real estate, but most people won’t have other income that qualifies for it.
Hedge Against Inflation
Real estate and more specifically rental properties are not only natural hedge against inflation, but they can even benefit from inflation. When there is rising inflation, the rental prices and home valuations have historically increased along with inflation. This is because having a home is a necessity and not a luxury expense that can be easily avoided. As a result, when it comes to real estate, inflation is not eating at your investment value as is the case with most other assets.
Actually, given the highly leveraged nature of most real estate investments, inflation can actually accelerate the returns. As inflation causes home values to increase, the leverage accelerates the rate of growth of the owner’s equity in the property relative to the debt. Let’s use an extreme and say for example you invest in a home with 20% down and there was a 20% inflation, that means you just doubled your down payment and doubled the equity you own in the home. Additionally, as inflation raises the rent payments while the interest payments stay locked at the same low rates, the cash flow from the property increases with inflation.
In this graph to the right we can see how during the 1900s housing prices have provided a very robust hedge against inflation and higher consumer prices. Equities have been the opposite and co-moved negatively with inflation prices.
At Arrived our goal is to make investing in real estate as easy as possible. Sign up below to browse our available homes and start your journey toward building financial independence through real estate investing.