Why Does Real Estate Create Wealth?
Real estate offers tremendous opportunities for wealth creation through multiple mechanisms: passive income, asset appreciation, tax benefits, diversification, leverage, and can also serve as a hedge against inflation.
There has been renewed interest in real estate as stock prices struggle, but real estate should not be viewed as a short-term investment strategy and is not without risk.
Reasons Why Real Estate Creates Wealth
- passive income
- Valuation of assets
- Fiscal benefits
- Diversification from the stock market
As of this writing, the average dividend yield for publicly traded REITs is 4.3%, according to the Motley Fool. Meanwhile, unlisted REITs had an average dividend yield of 8.1%.
Some REITs can pay significantly more dividends depending on the risk of the investment strategy.
Real estate investing can be a great way to generate steady cash flow.
Average publicly traded REIT equity: 4.3%
Unlisted REIT Average Dividend Yield: 8.1%
There are a number of factors that can affect property appreciation: location, interest rates, property improvements, and even inflation to name a few.
Most commercial real estate focuses on income generation or asset appreciation. According to the National Association of Real Estate Investment Trusts, the FTSE Nareit All Equity REITs' annual total return over the past 10 years has been 8.36%.
Meanwhile, single-family homes, i.e. your primary residence, will mostly benefit from increased property values.
According to the data of the Federal Housing Finance Agency, in 2012 As of January, the compound annual growth rate for single-family homes was 8.0%, according to the Federal Housing Finance Agency.
Total return for all equity REITs: 8.36%
Annual growth rate of single-family homes: 8.0%
The real estate sector provides a natural hedge against inflation. As inflation rises, real estate owners tend to increase rents on commercial real estate leases as they expire.
An article in the Wall Street Journal notes that inflation makes new construction more expensive, creating less competition from new construction and driving up the price of existing properties.
REIT dividend growth has outpaced inflation in 18 of the past 20 years relative to the Consumer Price Index (CPI).
And over the twenty years from 2000 to 2020, annual dividend growth was 9.4%, compared to 2.1% for the consumer price index, according to an analysis by REIT.com.
In general, real estate investors can deduct the normal costs of maintaining an investment property and some major expenses.
Significant tax deductions can include mortgage interest, property taxes, operating expenses, depreciation and repairs.
Most people can reduce the cost of keeping their rental property in good working order.
It's important to note that the tax breaks generally only apply to people who invest in physical real estate, not REITs.
Unlisted REITs have a ratio of 0.14 to equities. Correlation is how two assets move relative to each other.
A ratio of 1 means that if stock A goes up 10%, stock B will go up 10%.
Meanwhile, publicly traded REITs have a ratio of 0.68, according to real estate research by TIAA.
Because of this, real estate is less likely to experience losses at the same time or to the same degree as stocks, which helps reduce downside risk and mitigate the volatility of a diversified portfolio.
Note: While publicly traded REITs are not perfectly correlated with stocks, unlisted REITs or real estate investments through residential or commercial properties provide better diversification.
For ordinary investors, the number of ways to borrow money with less than 10% is limited.
Leverage can increase returns and reduce the total amount of cash needed to invest.
Let's use an example to illustrate the power of leveraging
What You Should Know Before Investing in Real Estate
Income through real estate investing can depend on real estate markets, employment, and even emerging technologies, among other factors. Market knowledge is critical whether you are investing in REITs or physical real estate.
You shouldn't do anything until you have considerable knowledge of your market. It's important to match your market to your opportunities, especially with residential or commercial properties.
Understand The Different Real Estate Investing Strategies.
There are 4 main real estate investment strategies: Core, Core Plus, Value-Add and Opportunistic. These strategies are primarily aimed at commercial real estate investments, but can also be applied to individual investment properties.
This is a buy and hold strategy when you buy a high quality property that generates steady income. Basic strategies involve lower risk but also have lower returns. Expected returns typically range below 10% IRR.
The core strategy is ideal for investors looking for passive income, and because the underlying properties are fairly stable, they don't tend to experience capital appreciation.
Like the basic real estate strategy, the key-plus approach focuses on a buy-and-hold approach, but with slightly higher risk.
Key investors create value by renovating and increasing the property's curb appeal, allowing the investor to collect a higher rent.
This strategy creates long-term wealth through increased property value and increased passive income.
Core Plus strategies typically generate around 10-14% internal rate of return.
Investors with a greater appetite for risk and reward may seek value-added strategies. Value-added investments focus on properties that require capital and day-to-day management to achieve profitability.
Value-added property investments include renovations to attract new types of tenants or to fill vacant tenants. Pursuing value-added opportunities can also provide investors with access to a market that would otherwise be too expensive.
Value-added investments typically have an investment horizon of 5-7 years and target an internal rate of return of 15-19%.
Opportunistic real estate strategies are the riskiest types of investments, but they also have the potential to reap the highest rewards. Most investments require significant leverage and the property may not provide any income for years.
Examples of opportunistic investments may include the development of a green field, the acquisition of a vacant building or the development of land.
Only an experienced team of real estate professionals usually undertake opportunistic real estate projects.
Opportunistic investments can have returns of more than 20%.
Ways To Build Wealth Through Real Estate
Many people typically associate real estate investing with buying and renting real estate or investing in fix-ups and flips.
However, there is a wide range of real estate investment strategies. The right real estate strategy depends on your risk tolerance, available capital and investment schedule.
Real Estate Crowdfunding
Real estate crowdfunding is a lesser known method of investing in real estate. Real estate crowdfunding has really taken off in popularity over the past ten years since the JOBS Act was passed.
Real estate crowdfunding is when people pool money together to provide financing for a residential or commercial property.
And if you're an accredited investor, there's an even wider range of investment services and platforms available.
Benefits of real estate crowdfunding
The resurgence of crowdfunding provides investment opportunities that have not historically been available to non-accredited investors.
In addition, real estate crowdfunding can generate passive income and capital appreciation. And most importantly, it doesn't require day-to-day management like fixing and changing or renting a property.
Benefits of Real Estate Crowdfunding
- No daily property management required.
- Access to properties unavailable through publicly traded REITs
- capital appreciation
Real Estate Crowdfunding Is Good For…
Individuals who do not want the responsibility of managing the day-to-day operations of physical real estate and are looking for returns that are typically higher than publicly traded REITs.
The main disadvantage of non-traded real estate is that the investments are quite illiquid, meaning you can't easily buy and sell your shares like a publicly traded REIT.
A REIT (Real Estate Investment Trust) is a company that owns, invests in, or finances commercial real estate.
The term REIT is really just a tax concept, and as long as a company meets a long list of requirements set forth by the IRS, it can qualify as a REIT.
The most prominent qualification requirement is that a company must distribute at least 90% of its income to investors to qualify as a REIT. This allows the REIT to avoid double taxation, once at the corporate level and then at the individual level.
TYPES OF REITS
REITs can be commercial or non-commercial; Commercial REITs are listed on a stock exchange and are easily bought and sold like stocks. Meanwhile, unlisted REITs are not publicly traded and are not easily bought or sold.
Popular Publicly traded REITs include:
- Vanguard VNQ. REIT ETFs
- Vornado Realty Trust VNO – Commercial Real Estate Primarily New York City
- Avalon Bay Communities AVB – Invests in multi-unit apartment complexes.
Buy A Home and Live In It
This is not a unique strategy. Home ownership can be the key to wealth for many Americans.
According to a census.gov study, home equity is the second largest source of household wealth for 99% of Americans, just behind stocks and ahead of mutual fund investments.
Homeownership as a primary source of wealth isn't a phenomenon, homeownership is a kind of forced savings mechanism because people can't easily take the equity out of their homes and mortgage payments account for more than 20% of Americans' take-home pay.
A Fix-and-Flip property is a type of investment property that needs renovations to make the property attractive to potential owners.
Fix and Flip properties can be incredibly profitable, according to AttomData, a national leader in property data, the average gross profit for flipped homes in 2021 was $65,000.
However, the main downside to a fix-and-flip property is that it requires a lot of capital to get started, considerable knowledge of the real estate market to make sure you're not overpaying for the property, and finally, the resources and time to hire the necessary labor. to make the property salable.
Skills required for booking and flipping properties:
- A large amount of start-up capital
- Knowledge of property and neighborhood.
- Resources and time to hire and manage labor to renovate the property.
If you are just starting to learn about real estate investing, a good alternative if you don't have the time or money to spend is to invest in a renovation and browse through a company called Groundfloor. They provide short-term residential real estate loans with an average loan duration of approximately 10 months.
For just $10 you can invest in real estate without buying a property and earn about 10% on average.
Fix AnD FLipping houses is good for…
Individuals who have the time, money and resources to manage a physical property and want to wash their hands of the property once it is renovated and sold.
With buy and rent properties, there are three primary investment options:
- Real estate rentals that generate income.The main disadvantage of this property is that you will likely pay a premium for this type of property considering the immediate cash flow you will receive.
- Buy and Renovate. This is when you buy a rental property and make renovations, which allows you to increase the rent. This strategy is known as real estate value added strategy. Buying and upgrading can be significantly more profitable, but also carries greater risks.
- Multi-Family Conversion. It involves buying a single-family home or property and converting it into a legal multifamily. This strategy is the most risky because there are many legal considerations that can backfire.
However, a versatile conversion can be the most profitable of the 3 buy-to-let strategies if executed correctly.
A 1031 exchange allows investors to exchange one investment property for another, thereby deferring the capital gains taxes payable.
A 1031 exchange is a good way for investors to upgrade to a more meaningful investment property that can generate additional rental income.
1031 exchanges can also be a great way to build wealth because the capital gains taxes you would now owe can be deferred.
The investor must follow a strict set of real estate rules, for example, that the exchange must be with the same type of Property.
Is Real Estate The Best Way To Build Wealth?
There is no “one size fits all” when it comes to building long-term wealth. And most importantly, you need to make sure that the investment opportunity matches your goals.
A well-diversified investment portfolio of stocks, bonds and real estate works well for most people, but there are endless stories of successful real estate entrepreneurs and investors that make it even more enticing.