REAL ESTATE INVESTING
There are advantages and disadvantages to every form of investment, the key to successful investing is understanding. Not only understanding the advantages and disadvantages but, of your own needs and threshold for risk.
LACK OF LIQUIDITY
The greatest disadvantage may be its lack of liquidity compared to other types of investments. It may take considerable time to sell a property depending on the type of property, property condition, and market climate. An investor who needs to sell a property quickly will most likely be forced to discount the price in a down market should they need liquidity. In general due to a large pool of buyers, single-family homes may actually have more liquidity than other property types.
Risks can be minimized by doing careful advance analysis of the property and locale and purchasing adequate insurance coverage. Holding the property for a longer period of time (7 years or longer) can help minimize risk as well.
Investing in real property, comes with the costs of ownership and management of your tangible asset. The IRS allows tax deductions for operating expenses and depreciation on real estate investments. Costs include but are not limited to: taxes, insurance, regular maintenance, repairs, tenant placement & possibly a property manager.
Unlike other types of investments, such as stocks and bonds, rental real estate generates a regular income stream. After paying the operating expenses for a property (on a good investment), the investor receives a monthly cash net return. Depending on the type of property there may also be other sources of revenue such as laundry equipment, parking, or access to fitness equipment.
Fluctuations in financial markets tend to have less impact on real estate than other investments. Rents and capitalization rates change slowly over time, so cash flows stay relatively stable. This is particularly true with commercial real estate, because leases may run for five years or more.
SAFETY OF A TANGIBLE ASSET
Real estate is safer than other investments because the investor owns a tangible, brick-and-mortar asset. Figure it this way, people will always need a place to live! Even if a building is damaged, there is still property underneath. When looking to open a restaurant of commercial business, when available, it is highly recommended to purchase the property.
ABILITY TO INFLUENCE PERFORMANCE
Long-term investors can increase the value of their assets by making improvements that make it more attractive to tenants, thus increasing rents, cash flow, and overall value. A short-term (aka fix-and-flip) investor buys low, renovates quickly, and sells high for a profit.
Real estate provides a natural hedge against inflation. Rent growth generally leads to increased net income—provided that operating expense inflation is less than revenue growth—and increases value.
An investor has the ability to borrow against the value of the property to purchase it. As the value of the property increases over time, the investor makes money not only on the initial investment, the monthly rent but also on the funds that were available for other investments.
The value of real estate tends to increase over time, on average, 4.4% per year. Historically an investor who buys and holds a property can almost always sell it for more than the purchase price.
DEPRECIATION (COST RECOVERY)
Because buildings and equipment wear out over time, the IRS allows an annual tax deduction for depreciation. The depreciation period for residential real estate is 27.5 years. This tax advantage reduces an investment property owner’s annual income tax bill.
A 1031 exchange defers taxes on capital gains as long as another like-kind property is purchased with the profit gained by the sale of the first property. Tax deductions are allowed for the costs of owning and operating the property, including advertising, insurance, interest payments, management, maintenance, and property taxes. Self-directed IRAs can own property, and defer taxes to retirement or use before-tax dollars in a self-directed IRA to purchase the property.
The real estate market is subject to the same fluctuations that affect the larger economy. As GDP grows and the market expands, demand increases, and rental prices go up accordingly. Eventually, the economy moves towards recession, demand reduces and so do prices.
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