When done the right way, real estate investing can provide great returns through rental income, tax advantages and the capital appreciation gained from buying below the market value.
However, investing in real estate is not for everyone. It takes time to learn to competently and confidently invest. It takes perseverance and effort to find awesome deals. And it takes financial discipline to save up enough money to get started. Let’s face it: Investing in the stock market is much easier!
Still, I have found that real estate is a much better way to invest my money than the stock market. I am making a much higher return on my real estate holdings than on my traditional stock portfolio. And real estate offers some unique qualities that make it attractive.
Here are five key reasons real estate investing beats the stock market:
1. Real estate investments provide cash flow and can be a hedge against inflation.
You’ve heard it said, “Cash is king.” Whether stock or real estate, your investments should be paying you cash that you can reinvest or save for your retirement. Rental properties give a steady source of cash. Buying the right properties is key, of course.
What’s nice about rental income is that your cash flow keeps pace with inflation. The market price for rental properties automatically rises as the cost of living increases.
You can also line up a big cash payday by buying a “distressed” or foreclosed property below the market value. Then you can fix it up and sell it a few months later for more than what you’ve paid — the purchase price and rehab and transaction costs.
You can choose to “fix and flip” to collect a windfall or hold and rent for monthly cash flow. Either way, investment properties can provide cash and a hedge against inflation.
2. Real estate is a market where you can buy low and sell high.
We all know money is made in the stock market by buying low and selling high. But it is nearly impossible for most investors to do so consistently. You can’t possibly know enough about an individual company, its sector, management, competitors, etc. And institutional buyers will always have more leverage and know more than you as an individual investor.
Contrast that with residential real estate where you are dealing with individual properties and each one is different in location, size, features and other criteria. There is no set market for the exact property you are considering.
In the stock market, anomalies are quickly adjusted for by other investors. In the real estate market, there are thousands of little markets. You can always find deals and “buy low.”
There are strategies where you can buy low and sell for a high price once you have rehabbed a house. And there are geographical pockets in just about any real estate market where you can “sell high” if you know the type of housing that is in high demand.
3. Actively managed real estate provides better returns and lower risk than stock market investing.
Stock market values go up and down. Independent research firm Dalbar has been measuring the effects of investor activities over both short- and long-term time frames since 1994. They show that average investors are not very good at capturing the market return of a simple balanced portfolio. Never mind outperforming it.
Individual investors tend to buy and sell at precisely the wrong times. That wipes out possible gains in an already efficient market where bargains are sparse.
On the other hand, real estate is nearly immune to emotional buying and selling. As a less liquid investment, panic selling is impossible. You have more facts to make a better investment choice initially when you buy properties.
And the long-term nature of real estate assets ensures that you hold on through ups and downs. All the while, rents and property prices rise due to inflation.
In general, your risk of loss goes down the longer you hold real estate investments. Your equity builds and home prices rise over time. That is unlike the stock market, where the risk typically stays the same.
4. Real estate investing provides unique tax advantages.
While there are others, depreciation is the tax advantage that most investors have heard about. For dwellings, the IRS allows you to deduct the cost of the property over 27.5 years.
What real estate investors love is that you are depreciating an asset that does not often lose value. In fact, property values tend to go up over time. That means you get a tax credit on the cost of an asset that may be going up in value, not down.
What is more, depreciation is a tax credit that is on top of property upkeep and other costs that you can take away from the rental income you get. When you take it, it provides a tax deduction that lowers your tax liability. That means more money that you can use to buy more properties. Or pay off the loan if you took one. Or pay for upkeep or anything else you want to spend it on.
5. Real estate investors can use leverage to build wealth.
Leverage is a tool that many real estate investors use to build their portfolio of income-producing properties. Getting a mortgage to buy a rental property gives you leverage that you can use to invest in more properties (and different types of properties to spread your risk) with less money down.
Say you put 30% down on a $100,000 property. You are controlling an income-producing asset worth more than three times your cash investment. You are earning rent from a $100,000 property when all you invested was $30,000.
Well-selected rental properties will be cash flow positive. That means that your annual rental income will pay all the costs (mortgage, taxes, insurance, maintenance, management fees, etc.). It will also give additional cash for your bank account.
Of course you need to critically evaluate your strategy, the specific deal, and the terms of your loan. You can get easily in over your head with leverage. Being overleveraged greatly increases your risk. Leverage is a tool that needs to be managed and monitored. Any specific property or an entire portfolio can be made risky with high leverage.
Summary
I have found that real estate provides many advantages over the stock market. You can make returns of more than 10% on the cash you invest from rental income. Your investment provides monthly cash flow, and residential properties typically go up in value, providing capital appreciation.
With real estate, you have much more control over the underlying asset. That means there are many opportunities to buy low and sell high. When you buy below market value, you can build $20,000 or more of instant equity.
The tax advantages of rentals can save you thousands of dollars each year, thanks to depreciation. When you get a mortgage on an investment property, the rental income pays down the loan every month, building your equity in the property.
I do want to stress that you can’t just go out and buy any property. As a real estate investor, it’s crucial that you buy below market value. That means you need to put in the time and effort to find deals and do careful and complete research.
I pass on many more deals than I invest in. Many offers I make are turned down by the seller. It is common for sellers to believe their property is worth more than the market will bear. They do not know what repairs are needed or what rehab construction costs. They often do not see the issues that make the property unsalable in its current condition.
So asking prices can be high, and offers below the asking price are often turned down. That is just a reality of real estate investing. I have purchased less than 2% of the properties I have looked at in the last 12 months. But the deals I have moved forward with have performed much better than any stock investment I have ever made.
Comments
Hi Ruth – Really feel like you hit some solid points in the article! Leverage, when used appropriately really is a powerful tool. Thank you for a great read.