A disclaimer: we do not endorse investing in real estate, nor hope to argue that real estate is a great investment vehicle. What we hope is for you to apply a thought- process whenever an opportunity presents itself.
We suggest to analyze an opportunity as follows:
Current income: defined as gross income minus operating expenses, current income excludes debt service and tax payment. It is an industry practice to compare between properties, and to reduce the effects of leverage and one's tax position, it is termed Net Operating Income (“NOI”).
Compared to the yield offered by the typical bank, of say a 2.1 percent five-year certificate of deposit, real estate may provides not only a higher current income, but also the potential for price appreciation.
Price appreciation: one of the golden rule in investing is “Buy low, sell high” right? it applies to real estate. The argument for price appreciation is both intuitive and logical. It is intuitive because (1) land is scarce, (2) urbanization is increasing, and as a result, (3) the demand for housing grows. The logical side is a simple formula used in economics: if demand for x increases, all else equal, the price of x appreciates.
Inflation hedge: historically, property owners were able to pass on inflationary pressures to tenants. Just ask anyone above the age of 50, what was their rent like while in college.
Diversification: “Real estate is great because it is Bloomberg-free” said an institutional wealth advisor. Because daily market quotes are absent, the investor tends to distinguish between capital market volatility and actions better compared to the purchase of stock.
As a result, the relationship between capital markets value and real estate values is lower than with equity or debt markets.
Tax benefits: depreciation and interest deduction allure investors. Between 10 to 20 percent of taxable income is offset by depreciation in the first five years. Add to that an interest deduction equating to 30 percent of taxable income, add to that deductible fess such repair and maintenance, and the investor pays 40 percent of taxable income. ompared to other investments, real estate allows the highest amount of leverage. And so, the highest amount of interest deduct is taken at time.
Equipped with the understanding of real estate investing, we can compare between real estate and other investment asset classes.
Bonds lack inflationary hedge and price appreciation. If interest rates rise during the term of the debt, the value of the coupon decreases because other bond offerings will offer a higher interest rate.
Bond lack price appreciation by definition. What you lend to the company is what you get back. And yet, bond do not require active management; may offer liquidity, especially Treasuries; and may offer tax benefits as in the case of municipality bonds.
Stock market values indifferent to the investor opinion. The investor cannot affect company decision; and to sale one’s position is the only remedy. With real estate, the investor can choose to change a roof and to change the tenant mix.
And yet, historically, stocks provided greater long term wealth than real estate; and offered higher diversification by allocation to various position.
Real estate investing offers many benefits. Prestige and a desire to build are unique attribute to real estate inviting as well. What as true 2,000 year ago, remains now: buildings serve as means to impress, to fulfill dreams, and to affect a community. Our purpose in this article was to share with you reasons for investing in real estate, but not in any means, argue for its superiority, or a certain positive outcome.