The benefits of investing in real estate are so many. With well-chosen assets,an investor can enjoy predictable cash flow, profitable returns, tax advantages, and diversification.
Are you thinking about investing in real estate? Here's what you need to know about real estate benefits and why real estate is considered a good investment.
KEY TAKEAWAY
1. Real estate investors make money through rental income and profits generated by business activities that depend on the property.
2. The benefits of investing in real estate include stable cash flow, tax advantages, diversification, and also leverage.
3. Real estate investment trusts (REITs) offer a way to invest in real estate without having to own, finance or operate properties.
Cash Flow
Cash flow is the net income from a real estate investment after mortgage payments and operating expenses have been made. A key benefit of real estate investing is its ability to generate cash flow. In many cases, cash flow only strengthens over time as you pay down your mortgage—and build up your equity.
Appreciation
Real estate investors make money through rental income, profits generated by property-dependent business activity, and appreciation. Real estate values gets to increase over time, and also with a good investment, you can turn a profit when it's time to sell. Rents also tend to rise over time, which can lead to higher cash flow.
Build Equity and Wealth
As you pay for a property mortgage, you build equity—an asset that's makes part of your net worth. And as you build equity, you have the leverage to buy more properties and increase cash flow and wealth even more.
Portfolio Diversification
Another benefit of investing in real estate is its diversification potential. Real estate has a low—and in some cases negative—correlation with other major asset classes. This means the addition of real estate to a portfolio of diversified assets can lower portfolio volatility and provide a higher return per unit of risk.
Real Estate Leverage
Leverage is the use of various financial instruments or borrowed capital (e.g., debt) to increase an investment's potential return. A 20% down payment on a mortgage, for example, gets you 100% of the house you want to buy—that's leverage. Because real estate is a tangible asset and also one that can serve as collateral, financing is readily available.
Competitive Risk-Adjusted Returns
Real estate returns vary, depending on factors such as location, asset class, and management. Still, a number that many investors aim for is to beat the average returns of the S&P 500—what many people refer to when they say, "the market." The average annual return over the past 50 years is about 11%.5
Inflation Hedge
The inflation hedging capability of real estate stems from the relationship between GDP growth and the demand for real estate. As economies expand, the demand for real estate drives rents higher. This has been translated into higher capital values.
Competitive Risk-Adjusted Returns
Real estate returns vary, depending on factors such as location, asset class, and management. Still, a number that many investors aim for is to beat the average returns of the S&P 500—what many people refer to when they say, "the market." The average annual return over the past 50 years is about 11%.5
Real Estate Investment Trusts (REITs)
If you want to invest in real estate, but aren't ready to make the jump into owning and managing properties, you may want to consider a real estate investment trust (REIT). You can buy and sell publicly-traded REITs on major stock exchanges. Many trade under high volume, meaning you can get into and out of a position quickly. REITs must pay out 90% of income to investors, so they typically offer higher dividends than many stocks.6
The Bottom Line
Despite all the benefits of investing in real estate, there are drawbacks. One of the main ones is the lack of liquidity (or the relative difficulty in converting an asset into cash and cash into an asset). Unlike a stock or bond transaction, which can be completed in seconds, a real estate transaction take months to close. Most times even with the help of a broker, it can take a few weeks of work just to find the right counterparty.
But then, real estate is a distinct asset class that's simple to understand and can also enhance the risk-and-return profile of an investor's portfolio. On its own, real estate offers cash flow, tax breaks, equity building, competitive risk-adjusted returns, and a hedge against inflation. Real estate can also enhance a portfolio by lowering volatility through diversification, whether you invest in physical properties or REITs.
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