Investment Newsletter Sign Up
Total Future Cash Inflows =
(Number of Payment Periods Left x Payment Received per Period) + Property Value (If it will be sold)
Visit the Calculating Value in Real Estate Page to learn how to value properties using calculations such as CAPM, NPV, and Capitalization Rate.
Advantages of Investing in Real Estate
Real estate investing is a great way to add diversification to any investment portfolio. The low price volatility, tax benefits, and fixed income earning make this form of investment a cornerstone of many forms of investing, particularly for investors nearing retirement. Here are 7 Advantages of Investing in Real Estate:
1. Real Estate is a Hard Asset – Real estate assets are able to be improved and they are tangible assets. There are several advantages to investing in tangible assets and they center around lower price volatility.
2. Solid Downside Defense – Unlike stocks that are pieces of paper that entitle an investor to future cash flows of a company and a priced using a potentially volatile P/E (price-to-earnings) multiple, real estate has a pretty consistent downside defense. The book value of real estate is fairly consistent and almost never goes from full value to zero like stocks potentially can.
3. Good Hedge for Inflation – Historically, real estate has been a smart way to hedge your wealth for inflation. Inflation is the overall price level rise that happens over time, which erodes overall wealth. As overall prices rise, real estate assets are likely to rise with them, which helps to protect the investor’s wealt
4. Leverage – Real estate is perhaps one of the easiest forms of investment for using loaned money from banks to leverage an investment. That is, using borrowed funds that result in a longer-term fixed expense in order to increase purchasing power and long-term earnings. Leveraging an investment comes with inherent risks; however, if done properly in real estate investing, the full amount of the mortgage payments plus interest is paid to the investor by the home-buyer/tenant
5. Tax-Free Cash Flows – While the real estate asset is depreciated, cash inflows from home-buyers/tenants are offset by the the depreciation amount. This results in substantial tax savings. Furthermore, profit made by selling real estate assets in the future is taxed as capital gains
6. Tax Write-Offs and Deductions – Investing in real estate becomes a business of sorts; therefore, any travel or management fees are tax deductible.
7. Real Estate Generates Fixed Income – Many types of investors, especially investors nearing retirement, need or prefer to generate returns as fixed income earnings. Fixed monthly payments that are fairly consistent can help support any individual, especially those retiring and needing a steady source of income to subsidize their retirement.
Although, like any investment, there are risks that are unique to investing in real estate.
1. Default or Unfulfilled Contracts – Investors, especially lower credit investors, can potentially default or walk out on any contract, which would leave real estate investors to have to find another home-buyer/tenant on short notice. Furthermore, when a home-buyer/tenant leaves, the fees associated with the property are left to the investor along with fees associated with finding another person or persons to take their place.
2. Cash Intensive Investment – Real estate investments may require a large amount of money up front to get going.
3. Properties Must Be Managed – Real estate properties and tenants need to be managed, either personally or in the form of a property manager. Either option can be costly in time or in money, especially when there is more that one property to manage.
4. 2007-2009 – Many investors think about the financial crisis when they think about investing in real estate. While the investment bubbly that burst at the end of 2007 was a somewhat rare occurrence, real estate, like any form of investment, fluctuates between over-valued and under-valued. This usually is maintained within a band of fair prices but this can reach extremes in rare instances and that is something that the investor should be prepared for because reaching these extremes will increase investment volatility. Good news is, often these instances can be spotted by the intuitive investor.
Real estate investments are a great way to diversify any investment portfolio and should be in most portfolios. While there are a few mentioned risks of investing in real estate, the advantages that this form of investing can have on a portfolio far outweigh certain risks. Since this form of investing, especially Sage Resources Properties, offer a return far in excess of risk-free government T-Bills, risk is to be expected. With risk comes return and savvy investors can spot opportunities and threats to manage risk and earn a healthy return.
Other relevant sources of information:
Simple Ways to Invest in Real Estate Article on Investopedia
Real Estate Investing on Wikipedia