Real Estate is a Hard Asset That Should be in Every Investor’s Portfolio
There are many great reasons to invest in real estate. While it should not be an investor’s only asset, it should be a significant portion of their holdings, since owning real estate is a natural hedge against inflation. Consider whether you would rather hold cash in the bank paying 1% interest for ten years when inflation is 3%. Under this scenario the investor would be losing 2% of their investment per year. While real estate is cyclical, which we have all learned over the last five years, over the long term (10, 15, 20 years), prices, including real estate prices, tend to rise at least at the same rate as inflation (i.e., over the last ten years, New York City real estate prices rose at twice the level of inflation). In addition, leveraging the real estate purchase, which is explained in detail below, could multiply this return on investment.
Each Investor Has Their Own Goals When Investing
Some investors prefer to receive monthly income from their investments, so they choose to pay cash for their real estate investments. This will provide cash flow to the owner, who can use this money for living expenses, savings, or more investing. Other investors prefer to forego cash flow and focus on capital appreciation. Investors do this through leveraging their real estate purchases by obtaining a mortgage. Using a mortgage to buy property enables the owner to buy a much larger property with the same initial investment, allowing for a greater overall return in a period of rising prices.
Leveraging is a Powerful Tool to Increase Return on Investment
Financing a real estate purchase (a.k.a. leveraging) can significantly increase one’s return on investment while at the same time acting as a hedge on inflation. Under the following example, if you had purchased a $1,000,000 property by investing $500,000 in cash and obtaining a $500,000 mortgage, and ten years later the value of the property was $2,000,000, you would have received a 300% return on your investment. If you had paid cash for the same property, your return would have been closer to 100%. That is a huge difference in return on investment using the same amount of investment, so if you are financially secure and can safely service the mortgage without any risk of financial distress, you should seriously consider this approach to investing. To learn more about leveraging your real estate investment, go to the Mortgage Finance page.
Financed Real Estate Investments are a Natural Hedge Against Inflation
Since US interest rates are at record lows, smart investors will use this access to cheap financing to deploy funds into long term value investments, like real estate. Buying an investment property with a 60% loan-to-value fixed rate loan is an excellent hedge against inflation for two reasons: 1) much like commodities, real estate tends to increase in value at least as much as inflation (or higher, as the case has been for NYC, which has risen at double the level of inflation over the last ten years); and 2) you will be able to pay off the mortgage that was borrowed in today’s dollars with tomorrow’s less valuable dollars (if inflation occurs).
US Tax Law Favors Real Estate Investment
Since the US government allows the owner of property to deduct many cash and non-cash expenses, such as depreciation of the purchase price over 27.5 years, an investor will not pay taxes in the first years of owning a property. Provided the buyer leverages the real estate purchase with a mortgage, this will extend up to 15 years, since mortgage interest is also deductible for tax purposes. In addition, since the Internal Revenue Service allows for the carry forward of losses to future years when there is income, even if there would have been taxable income, the movement of losses from early years to later years, which are netted against income in those years, effectively erases any income for at least the first 15 years of owning the property. To learn more about this topic, see both the Cost Components of a Real Estate Investment and Real Estate and Related Taxes pages.