Real Estate Creates Wealth

As a vehicle for creating wealth, financial experts agree it's hard to beat real estate. Of the four benefits all investors seek (income, tax advantages, appreciation and leverage), no other single investment offers as much as real property.

The first thing many investors want to see is income. While there are any number of investments that may offer this benefit, few can produce as much income relative to the cash invested as real estate. Rental income that exceeds a property's expenses creates a positive cash flow for the investor. With a fixed-rate mortgage, an investor can insulate a large part of his costs against rising property values. Then, as rents increase so does cash flow.

Infinite Return

How much or how little cash an investor puts up greatly affects the yield in rental properties. If, for example, a property has a positive cash flow of $2,000 a year but the investor had to come up with a $10,000 down payment to make the purchase, the return would be 20 percent per year. Not bad, but if the same cash flow could be maintained with a $5,000 down payment, the return would be 40 percent. Using a no-money-down technique to purchase the property could yield an infinite return. The tax benefits of real estate are many. Besides mortgage interest, property taxes and a slew of other deductible business expenses, there is depreciation, which in some cases can provide tax losses to offset other personal income.

Property appreciation is yet another way real estate builds wealth. The National Association of Realtors has been tracking home prices since 1968. Home values have increased each year at an average rate of inflation plus one to two percentage points. The longer a property is held, the more likely an investor is to profit from resale, unless the property was purchased at below market value, in which case appreciation would be immediate. But whether instant or gradual, appreciation can create fortunes.

True Return

But the true return on real estate shouldn't be measured by just income tax benefits and appreciation. Leveraging borrowed funds gives a return far in excess of the property's appreciation rate. An investor may put down 10 percent on a property, but might reap an annual return of 100 percent as a result of the price appreciation. According to the Joint Center for Housing Studies, even a modest 3 percent annual rise in the value of a property bought with 10 percent down generates a 34 percent annual return on invested capital if the property is held at least three years.

Leverage

The less an investor puts down, the more leverage. Usually the greater the leverage, the higher the mortgage payments, so care must be taken in property selection and contract negotiations to be sure the property will support the payments. As if these benefits aren't enough, there's one other that absolutely no other investment provides, and that's shelter. Whether for your family or for your tenants, when you invest in residential real estate you are providing someone with a home.

by Carlton Sheets