Why is real estate such a good investment? It offers at least five different returns or ways of making money on investment compared to other forms of investment.
1. Gross spendable income – Cash flow
Investors also refer to this as “cash flow” or how much money you can spend at the end of the month or year after all the operating expenses and mortgage payments have been made. We also call this “gross” spendable because we have not taken income tax consequences into consideration at this point.
We always purchase properties that generate cash-flow. It takes time to find them, but it is well worth the effort. The simplest definition of positive cash flow is that you collect more revenue, usually in the form of rent, than it takes to pay for and operate the property.
A big advantage of real estate over other investments is that it can produce cash flow on a monthly basis. The cash generated by a real estate investment will always be a much larger percentage cash-on-cash return than any other investment. The beauty of a cash-flowing real estate property is that it can help you become financially free. We discussed two real life examples of such real estate property in How to know if a property investment is worth investing?
2. Equity income
This is also referred to as equity buildup or principal reduction. Anyone who has had a mortgage on a home or car recognises that each time a payment is made, a certain portion of that payment is for the interest charged by the lender and the balance goes toward reducing the balance on the loan.
In a real estate investment, this equity income can be a sizeable amount. Although you cannot spend it each month, when the time comes to sell or refinance your property, you owe less on the mortgage, so you will receive more money at closing. It’s like putting money in the bank each month, while this money is helping you to reduce the mortgage loan interest by lowering the outstanding loan amount every month.
3. Making inflation work for you instead of against you – Appreciation
Like inflation, you do not see it but it’s there. Only now, it’s working for you instead of against you. How does it work? Each year, because of inflation, your real estate is appreciating in value. As prices go up, so do rents; as rents increase, the value of your real estate increases. Those of you who own a home, for example, would you sell it today at the same price you paid for it five or ten years ago?
We keep on having babies but God quit making land a long time ago. The supply is limited. What does this mean in terms of existing land values? It means that existing land is becoming more and more valuable each year. It explains why investment real estate, whether in single family homes, apartment buildings, office buildings, shopping centres, warehouses and even vacant land, has become the most secure and profitable way to beat inflation. Existing land in most parts of the country, is appreciating at a rate greater than that of inflation.
4. How real estate stacks up against other investments – Leverage
Leverage is an interesting thing about investing in real estate. It’s more than likely you have heard the term Other People’s Money, or OPM. The concept is simple and powerful.
The OPM concept is using money generated from someone or something other than you in order to start a business or to acquire an asset. While it is true that you can do this to an extent with stocks through buying on margin, the fact is that there is no investment where the application of this tool is more powerful than in real estate.
In real estate the leverage is based on the asset itself and you can get a bank to loan you the money up to 90 percent of the total asset value. Why do banks do this?
Because they can repossess the physical asset itself should you default. Buying stocks on margin, however, allows you to borrow no more than 50 percent of the stock portfolio value. Just try to get a bank to loan you the money for buying stocks – let alone your margin! Instead, you have to buy through a brokerage – at a high interest rate. In other words, when you buy stocks on margin, you are taking the risk. But when you take out a loan to buy real estate, the bank is assuming the risk. – Ken McElroy in “The Advance Guide to Real Estate Investing”
You can see the power of leveraging demonstrated by real life cases in our previous article Why you want to take up a loan for your real estate investment? No other form of investing allows an investor the opportunity to control so much with a small amount of his own cash.
5. An investment that allows you to control
A unique advantage to real estate is that you can control it. In other types of investments, you give your money to a financial advisor and they place it for you in a company’s stock, a bond, or a mutual fund. What happens after that is completely out of your control. You have no ability to make operating decisions for the company you have invested in – you are at the mercy of its managers.
Similarly, you have no control over financial markets when you purchase bonds or futures. You make a calculated guess, and then you sit back and watch. With these types of investments, the only control you have is choosing whether to buy or to sell.
Real estate is different. You purchase a tangible asset and you manage it. While there are still external market conditions that affect your investment, the difference is that you have the ability to manipulate the operations of your investment to respond to those conditions. Instead of being reactive (buying or selling), you are being proactive.
The big negatives for real estate investment – low in liquidity, high transaction cost and lengthy transaction time…