“Real estate cannot be lost or stolen, nor can it be carried away. Purchased with common sense, and managed with reasonable care, it is about the safest investment in the world.”
-FDR
Whether your real estate experience comes in the form of buying a home, securing a mortgage loan, or working as a small-scale landlord - you likely understand the ABCs of the real estate world. Instead of reviewing information you may already know, let’s focus on answering this question: Is real estate the right investment for you?
This type of investment is the process of producing revenue and/or profit from real estate assets. Returns are impacted by property appreciation, rental income, use of leverage, and tax benefits. The right real estate investments can improve returns and diversification while acting as a hedge against inflation.
As an asset class, real estate has some unique characteristics that are not duplicated by other asset classes (stocks, bonds). Other asset classes don’t compare to real estate's combination of appreciation, cash flow, and tax advantages. Let's take a look at a few of the qualities that make real estate such an attractive investment.
As of 2018, average 20-year returns on real estate investments ran between 9.5% for commercial real estate and up to 11.8% for real estate investment trusts (REITs). These numbers slightly outpaced the S&P 500 average for the same period. In addition, real estate was subject to lower volatility compared to the securities that are sold by Wall Street. Reduced volatility helped real estate produce competitive risk-adjusted rates of returns.
With a commercial investment, like a multifamily apartment building, a sizable portion of your total Return on Investment (ROI) accrues from rental income over the life of the investment. Real estate values have consistently increased over the past seven decades, despite brief interludes like the 2008 market crisis. Why you ask? Because most of the return from real estate investments over the past decade was derived from rental income and not market appreciation.
It doesn't matter if you're buying a small multifamily building or a large retail complex- investments in commercial property can benefit from several tax breaks and benefits. If you are financing the property, the interest you pay on the mortgage is tax-deductible. You can also take advantage of depreciation expense. As soon as you purchase a building, the value of the physical structure begins to depreciate.
The IRS allows you to use depreciation to offset your annual tax liability based on a published schedule. Other tax benefits include post-sales tax savings, deduction of non-mortgage-related expenses, and capital gains reduction.
Real estate can help lower your overall investment volatility. Real estate assets typically have low or negative correlation with other major asset classes like equities. For example, inflation can have a negative impact on the stock market and a neutral to positive impact on real estate investments that produce rental income. You can preserve and grow your portfolio with the right real estate investment strategy.
GDP growth and real estate demand share a positive relationship. During an expansionary period, real estate demand goes up, thus driving up rents, which eventually leads to higher capital values. In multifamily and other lease or rental-based real estate investments, much of the inflationary pressure of a roaring economy gets passed through to tenants, allowing your capital to appreciate at a better rate than other asset classes.
There are several possibilities when you choose to invest in commercial real estate. You can work with a wealth advisor, buy shares of a REIT, or even take advantage of the power of crowdfunding to get in on a project or portfolio you otherwise could not afford.
Following are a few of the ways you can make your money work for you when you invest in real estate.
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You can search for and purchase a real estate asset directly. For example, you could buy a 10 unit apartment complex that is charging under market rental rates, make significant improvements, and increase rents thereby increasing the value of the property.
Due to the need for specialized expertise, you may be more comfortable using the services of a real estate expert to make improvements and manage properties for you.
Real Estate Investment Trusts, or REITs, appeal to investors who want to maximize the diversification of their real estate investments and be hands-off at the same time. These are the mutual funds that invest in all types of real estate investments including equity and mortgages. Equity REITs represent equity ownership in properties, mortgage REITs represent debt that is used to buy properties, and Hybrid REITs do both.
Crowdfunding is a relatively new way to invest in real estate. Before passage of the 2012 Jumpstart Our Business Startups, or JOBS Act, it was illegal to market private real estate investments except to accredited investors. After the passage of the act, the first real estate crowdfunding platforms started up. Globally, the crowdfunding industry is set to surpass $93 billion by 2025, with a large portion of that growth in crowdfunding for real estate investments.
Instead of investing in one or two projects, crowdfunding makes it possible for people to make small investments in multiple projects, thereby increasing their diversification. This form of real estate investment has the same benefits as direct equity investment.
Real estate's combination of property appreciation, stable cash flow, and tax advantages make high quality real estate investments an excellent addition to any investor’s portfolio. Increased diversification, so all of the assets in your portfolio are not impacted by the same economic events (rising interest rates or inflation), is another benefit that is relatively unique to the real estate asset class.