There are many different ways to invest your money and grow wealth, but investing in real estate is among the best options. Real estate offers a number of distinct advantages that most other investments simply can’t match.
If you’re trying to decide where to invest your money and evaluating different options, this article covers the specific benefits of investing in real estate. Look at these benefits and see if they align with your own personal situation to determine if real estate could be a good fit.
Types of Real Estate Investments
We’re talking about real estate in a general sense, but there are several different ways to invest in real estate. Here are the top 3 options. The reasons to invest in real estate covered in this article are based on these 3 options.
The first and most common type of real estate investment is a rental property. You purchase a property, usually with the intention of holding it for the long term, and then you find tenants who pay you rent each month. The rent covers the mortgage payment, taxes, insurance, and any other expenses associated with owning the property. Anything left over is profit.
While rental properties are the traditional way to invest in real estate, this option isn’t ideal for every investor. As a landlord, you’ll be responsible for managing the property and dealing with tenants (unless you hire a property manager). Depending on the property and the tenant, there may be a lot of work and time involved.
The other two options listed below are more ideal for someone looking for a passive hands-off investment.
Real Estate Crowdfunding
Real estate crowdfunding is a newer way to invest in real estate, and it’s growing in popularity. With this option, you can invest in a property (or a portfolio of properties) without actually owning it yourself. Instead, you’re pooling your money with other investors to finance the purchase of a property. Once the property is purchased, a professional management team handles all the details and day-to-day operations.
Crowdfunding offers many of the same benefits as investing in a rental property, but it requires less time commitment from the investor. It’s also a great way to diversify your portfolio and spread out your risk by investing in multiple properties at once.
REITs, or real estate investment trusts, are a type of company that owns and operates income-producing real estate. They’re required by law to distribute at least 90% of their taxable profits to shareholders in the form of dividends.
There are different types of REITs including publicly-traded and private. Private REITs are generally illiquid, but publicly-traded REITs can be bought or sold just like a stock or ETF. As a result, a publicly-traded REIT is one of the rare ways to invest in real estate without tying up your money for several years.
There are also a number of real estate exchange-traded funds (ETFs) that invest in a collection of REITs, which is another easy way to invest in this asset class. You can see our list of the best real estate and REIT ETFs for some ideas.
Benefits of Investing in Real Estate
Now that we’ve covered the most popular types of real estate investments, let’s look at the specific reasons to invest in real estate.
1. Portfolio Diversification
Investing in real estate can help diversify your investment portfolio and reduce your overall risk. That’s because real estate behaves differently than other asset classes like stocks and bonds.
A diverse portfolio will include investments that don’t all move in the same direction at the same time. That way, if one investment is losing value, another may be gaining. This can help offset losses and smooth out your overall returns over time.
While real estate has a low correlation to stocks and bonds, it’s not completely uncorrelated. That means there will still be volatility and risk involved. However, investing in real estate can help mitigate some of the risks that are inherent in other investments.
Likewise, you can even add more diversification by investing in different types of real estate or by investing in real estate in different locations. For example, you could invest in a rental property, a REIT, and a real estate crowdfunding deal. Or you could invest in a property in New York City and another in a smaller city or town.
The more diversified your portfolio is, the better protected you’ll be during an economic downturn.
2. Potential for Excellent Returns
Of course, the goal of any investment is to make money. Real estate returns will depend on a number of factors including the location, type of property, and current market conditions. However, investors have the potential to earn returns that equal or surpass long-term returns from the stock market.
And while there will always be ups and downs in any market, investing in real estate provides the potential for more stability than other investments like stocks and bonds. That’s because people will always need a place to live and work, no matter what the economy is doing.
It’s important to note that you can lose money by investing in real estate. But, overall, real estate provides a solid investment opportunity with the possibility for excellent returns.
So real estate is not only effective for diversifying your portfolio, but it can also help you to get better returns.
3. Proven Track Record for Long-Term Investors
Another reason to invest in real estate is that it has a proven track record for long-term investors. Countless millionaires and moguls have made their fortunes primarily through real estate. If you’re looking for a proven way to build your net worth, investing in real estate is easily among the best options.
Of course, there will always be ups and downs in any market. So it’s important to remember that past performance is not necessarily indicative of future results. However, the dips are usually only relevant in the short term. The longer you’re investing, the better you are protected from declines in the real estate market.
4. Passive Income / Cash Flow
Investing in real estate can also provide you with a source of passive income. That’s money that you make without having to actively work for it.
The most common way to generate cash flow from real estate is through rental properties. You can purchase a property and then rent it out to tenants. Of course, being a landlord isn’t entirely passive. There will be some work involved in finding tenants and maintaining the property.
Investors who are looking for truly passive income may prefer real estate crowdfunding or REITs. The specifics will vary from one investment to the next, but generally, you’ll earn dividends that may be paid out monthly, quarterly, or annually. You can also reinvest those dividends to generate even more cash flow, which is the ideal choice for long-term investors who don’t need the income right now.
If you’re interested in living off dividends, real estate crowdfunding and REITs are both very attractive options.
Investing in real estate also comes with the potential for appreciation, when the value of the property goes up over time.
For example, let’s say you purchase a rental property for $200,000. After a few years, the property may be worth $250,000. In this scenario, you’ve made a 25% return on your investment simply from appreciation. That’s on top of what you’ve earned through rental payments.
Of course, there’s no guarantee that your property will appreciate. However, if you’re careful about the properties you purchase and you’re planning to hold them for a long time, your chances of benefiting from appreciation are high.
If you’re investing through a crowdfunding platform or a REIT, you’ll still benefit from appreciation, even though it’s somewhat indirect. The value of your investment will go up as the value of the properties in the portfolio also goes up.
6. Tax Benefits of Real Estate Investing
Investing in real estate comes with a number of tax benefits that you won’t find with most other types of investments.
For example, you can deduct the cost of any repairs or improvements that you make to a rental property. You can also deduct the interest you pay on your mortgage, as well as any property taxes. These deductions can add up quickly and significantly reduce the amount of taxes you owe each year. (Be sure to check with a CPA or tax professional about your deductions.)
Generally, when you sell a property, you’ll pay capital gains tax on any profits. For most taxpayers, capital gains tax rates are lower than earned income tax rates.
In addition, when you sell a property, you may be able to take advantage of the 1031 exchange. This allows you to defer paying capital gains taxes on the sale by reinvesting the proceeds into another qualifying property.
The specifics of the 1031 exchange are beyond the scope of this article, but suffice it to say that it’s a powerful tool that real estate investors can use to minimize their tax liability.
7. Inflation Hedge
Investing in real estate can also be a good way to protect yourself from inflation. As the cost of goods and services goes up over time, so does the rent you charge your tenants. Over the long term, real estate tends to keep pace with inflation.
And, as we’ve already seen, if you’re reinvesting your rental income and taking advantage of appreciation, your returns are likely to be higher than the rate of inflation anyway. So, investing in real estate can help you keep up with the rising cost of living while also giving you the potential to outpace inflation.
Even if you invest through crowdfunding platforms or REITs instead of directly owning rental property, you’ll still benefit from increased rents with both residential and commercial properties that are a part of your portfolio.
Another advantage of real estate investing is that you can use leverage to increase your returns. Leverage simply means using borrowed money to finance your investment.
For example, let’s say you have $50,000 to invest in a rental property. You could purchase a property for $100,000 by putting down $50,000 of your own money and taking out a loan for the other $50,000.
If the property appreciates in value or generates enough rental income to cover the cost of the loan payments, you’ll be earning a return on both your own money and the borrowed funds.
Of course, leverage can also work against you if the value of the property decreases or it doesn’t generate enough rental income to cover the loan payments.
That’s why it’s important to be careful when using leverage and to make sure you’re investing in properties that are likely to appreciate in value or generate sufficient rental income.
9. Building Equity
Each month, a portion of your rental income goes toward paying down the mortgage on your investment property. As you make these payments, you build up equity in the property.
Equity is the portion of the property’s value that you own outright. So, if a property is worth $200,000 and you have a mortgage balance of $150,000, your equity in the property is $50,000.
As you continue to make mortgage principal payments, your equity will increase until you eventually own the property outright. You can then use that equity as collateral for a loan to purchase another investment property or for any other purpose.
Or, you could simply sell the property and pocket the profits. Either way, building equity in an investment property is a good way to grow your wealth over time.
Real Estate Compared to Other Investments
Let’s look at how real estate compares to some other common investment types.
Real Estate vs. Stocks
Investing in real estate is often compared to investing in stocks. After all, both are popular investment types that offer the potential for high returns.
However, there are some key differences between the two that you should be aware of before deciding which is right for you. For example, stocks are much more liquid than real estate (with the exception of publicly-traded REITs).
This means that it’s easier and faster to sell your shares if you need to access your money. However, stock prices can fluctuate a lot more than property values.
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Real Estate vs. Bonds
Another common investment type is bonds. Like stocks, bonds are also liquid, which means they can be sold quickly and easily if you need access to your money.
However, bonds typically offer lower returns than stocks or real estate. They can also be less volatile than stocks, which means their prices don’t fluctuate as much.
So, if you’re looking for higher potential returns and are willing to accept more volatility, real estate is a better investment than bonds.
Real Estate vs. Gold
Gold is often seen as a safe investment that can protect your wealth in times of economic turmoil. And while there’s no denying that gold can be a valuable asset, it doesn’t offer the same potential long-term returns as real estate.
Gold also doesn’t generate any income, whereas real estate can produce rental income and appreciation. So, if you’re looking for an investment that will grow your wealth over time, real estate is a better choice than gold.
The bottom line is that real estate offers a number of advantages over other common investment types. If you’re looking for an investment with the potential for high returns and long-term growth, real estate is something you should consider.
Final Thoughts on the Benefits of Investing in Real Estate
Investing in real estate can be a great way to build your wealth over time. The benefits of investing in real estate include the potential for high returns, appreciation, rental income, tax advantages, and more. As a result, real estate is often a part of a well-diversified portfolio.
Of course, there are also risks involved with any type of investing, so it’s important to do your research and only invest in a way that you’re comfortable with.