There are many investment options available these days, we will examine some of the most popular investment vehicles in relation to real estate.
Some common investments are Certificates of deposit (CDs), Bonds, Stocks, or mutual funds. CDs offer safety but low returns and tie up your money for the term of the deposit. Bonds generally have higher returns than CDs but also higher risk.
Bonds are debt securities where you are essentially offering the bond issuer a loan and they are paying a specific interest rate. Payments are made at fixed intervals usually semiannually or annually. The prices can change due to market conditions such as the credit rating of the issuer, or changes in interest rates. Even expected changes in interest rates may affect bond prices, so they do have some risk.
Stocks are shares of a company that let you become part owner of that company. Stocks have historically offered the highest returns and as expected the highest risk. We all know the names of companies that have gone bankrupt and never returned. The money of shareholders usually never returns in those cases either.
Mutual funds were created to give investors the ability to invest in multiple companies with just one purchase. Mutual funds are similar to stocks in that you are part owner, but you are part owner of an investment portfolio of stocks. This takes away some of the risk of having to pick a single company and allows diversification that otherwise would be difficult to obtain.
Historically stocks have had the highest rate of return compared to the other traditional investments we have mentioned, including real estate. However, this is usually compared to the rise in the price of real estate, called appreciation. The problem with this comparison is that it leaves out many of the most important aspects and advantages of real estate investing. Some of these advantages have great effects on returns.
Real estate investing provides the ability to finance a large portion of the purchase price. This allows investors to leverage the amount of money they have to invest, and with the financing they are able to control an asset that is valued at considerably more than the amount of money they start with. For example if you had $20,000 to invest and the bank would allow you to finance up to 80% of the appraised value of a property, you would be able to buy a property valued at $100,000! This has extreme outcomes for the potential profit of the investment. If you invested $20,000 in stocks and your portfolio rose by 10% you would have a portfolio valued at $22,000. If you invested $20,000 in real estate valued at $100,000 and the value of the property rose by 10% you would have an investment worth $30,000! That would be a 50% increase in your original investment! We have looked at an extreme case to establish the benefits of leverage. Now you can see that a small increase in value of a leveraged real estate investment can in fact result in a larger return than a unleveraged investment with a high-rise in value.
Real estate investing also offers tax benefits. With CDs, Bonds, and Stocks, you are taxed on your earnings. (There are some bonds that will give you tax-free income, but the interest rate is lower than the market rate generally*.)Real estate has tax advantages that you can deduct from your profit to lower your tax liability. Some of these deductions include mortgage interest; cost of repairs to the property, travel, and the biggest is depreciation. Depreciation is a deduction allowed for deterioration of the property over time. This is substantial; it allows you to write off the value of an asset that most likely is actually rising in value.
Everyone wants to invest to improve cash flow and be able to live a comfortable retirement. In our opinion real estate investing provides the best opportunity to achieve a financially improved future.
Let’s look at an example of two investors who have $40,000 to invest.
The first puts the money in a diversified stock portfolio and achieves an average return of 9%.
The second uses the $40,000 as a down payment to purchase a 3 family investment property with a 15 year mortgage that is valued at $200,000 at the time of purchase and it appreciates at 4.5% (half that of the stock portfolio)
In 15 years the first investor has a stock portfolio that is worth $153,522
In 15 years the second investor has an investment property that is paid for and is valued at $392,311
Things to note when you look at this example, is that the first investor will have to pay taxes on the earnings and received no income or tax benefit over the investment period.
The second investor has owned 3 units that may have created a positive cash flow during the investment’s life and now that the property is paid. The investor has positive cash flow from the 3 rents until the investor chooses to sell the property. Owning 3 units today in most areas of Rhode Island you could expect to get at least $700 per unit. That is $2100 a month, or $25,200 a year in income that was created with an initial $40,000 investment. Keep in mind that rents will go up as properties appreciate so the income in year 16 and beyond will be even higher.
As you can see Real estate investing offers many benefits and potential for great profits. Nexus Property Management specializes in investment realty. We will work with investors to evaluate properties, purchase or sell properties and even manage the property after purchase if our client would like hassle free ownership.