The best thing to do with your money is to invest it in real estate. On the other hand, if you want to lose your money, real estate is a great place to do it. Both of these contradictory statements are true. Ultimately, real estate investing has significant advantages and disadvantages at the same time, and the decision to invest in real estate is unique to each investor.
Two Ways to Earn
Real estate offers two ways to earn returns. As you own rental houses and rent them out, you're hopefully collecting the difference between your rents and your expenses as profit. In addition to profiting from renting out your properties, you are also benefiting from its gradual increase in value. Even a 1- or 2-percent annual increase in value can add up to a significant long-term return when you combine it with paying down your loan and collecting your rents.
Real estate is also an extremely tax-efficient investment. The ability to depreciate buildings can cancel out some or all of your profits, letting you collect rental income at a favorable tax rate. Its value increases without you having to pay tax on it until you sell, and you may not even have to pay tax then. The Internal Revenue Service lets you sell your real estate and buy more investment real estate and, if you structure the transaction properly, carry your tax basis forward. This lets you defer paying taxes until you finally cash out of investment real estate.
Leverage may be real estate's greatest advantage and its greatest disadvantage at the same time. The ability to use borrowed money to invest in real estate amplifies gains and losses. If you put 20 percent down on a $200,000 property and it goes up in value to $220,000, that 10 percent increase in value corresponds to a 50 percent increase in equity, since your $40,000 down payment becomes $60,000. However, when the market goes down, the effect is equally drastic.
Management and Maintenance
Real estate isn't always easy to own. While larger properties are frequently managed by third parties, smaller investments like rental houses tend to be relatively expensive to manage with fees approaching 10 percent of the monthly rent. In addition, rental homes are prone to needing repairs or to experiencing vacancy. Finally, they also frequently require their owners and managers to have a lot of expertise in real estate, financing and construction matters. All of this can make smaller investments much harder to own than other investments.
Real estate isn't easy to sell. You can't just call a broker and turn your three-bedroom rental house into cash in a matter of seconds, minutes or even days. Once you've invested in an asset, you'll usually own it for a while. Not only can selling real estate be time-consuming, but buying and selling it is also relatively expensive. All of this makes real estate a better long-term investment than short-term investment in most cases.
- Comstock Images/Comstock/Getty Images