Why Buy Real Estate?

By Rob Mann Commercial Realtor, MHE, CREM

​Real Estate is a great investment.  It’s just about the only type where you get to use leverage and a tax shelter at the same time, plus it’s a hedge against inflation.  

The more money you borrow on an asset the better the internal rate of return will be.  This is why many investors want maximum leverage on every deal.  The benefits to owning real estate are rare, many fold and unique:

Mostly Passive Cash Flow.  This is the reason why most people buy investment property, they want their money to work for them when they are not working for it, meaning they want to generate money while sleeping.  Real estate is truly the opportunity to do so.

Leverage. Leverage allows you to both mitigate risk (by not using your own cash) and write off the interest payments on the borrowed money as a cost of capital expense. Leverage is a very powerful tool when investing but few investments allow it.  Think about it, what other passive investments allow you to only pay a fraction of the price using your own cash? Stocks? No. Bonds? No.  Precious metals? No.

Appreciation. The appreciation of your investment over time – is not guaranteed, but it is expected. This is due to the expectation that “a dollar today is worth more than a dollar tomorrow.”  

Hedge against Inflation.  When money loses it’s value (inflation), real estate maintains it’s value and the loan against it loses value.  Real Estate is a good hedge against inflation.

Tax-Free Refinance. The ability to refinance tax free is a benefit of investment property (and other properties) that very few investments offer.  With other investments like companies, money can be withdrawn from an asset but not in the same way and it’s often taxable.

Limited Liability. Limited liability in any business is a powerful thing; it means you’re not personally taking responsibility for everything you do to make money – and can buy insurance to cover those risks.  To do this, most property owners use an LLC to hold title.  Using an LLC to hold ownership and insuring the investment property are 2 ways that an owner of investment property can limit the liability of the asset’s risk.

Control. Having control is one of the most important benefits, but the one rarely stated.  Using leverage extends the control to the use of other people’s money.

Tax shelter. This is the ability to shelter income from the governments hands.  It is derived in 4 different ways.  

1. One tax shelter comes from the depreciation of the improvement value of the deal (you cannot depreciate land).  When you buy a residential property, the first year you buy it begins a 27.5 year depreciation cycle – where the improvement value of the property is paid back to you in the form of a tax credit (sheltering cash flow).  For other commercial buildings the depreciation schedule is a bit longer (39 years), however, an investor can achieve accelerated depreciation through an IRS strategy called Cost Segregation.  Cost segregation allows an owner to break the property into the sum of it’s parts – and use the individual depreciation schedules for each part instead of the property as a whole.
2. Another shelter comes from the expenses including mortgage interest that you write off against the property.  Since mortgage interest is a cost of capital, using a loan not only mitigates your risk, but it essentially costs you nothing – since that amount of cash derived from the property comes back to you tax free.
3. A third tax shelter is the effect that owning a property has on your tax bracket (typically it goes down).  When investors talk about real estate being “all about cash flow” this is why. With property comes deductions and with deductions come a reduction in your tax bracket.
4. The 1031 exchange rounds out the tax shelter advantage of real estate, while you can do a 1031 exchange on personal property, you cannot do it on a business.  The 1031 tax deferred exchange is simply the best way to build wealth – it states that you can make a capital gain on a property but defer the payment of that gain when you sell if you buy a like kind property with the proceeds.  There are rules to doing this, but it essentially allows you to leverage the money you would normally pay to the government in the form of an interest free loan on your next property.

Lastly, the benefit of the structure of an investment property (property vs loan) make is a hedge against inflation. Since the property is affected by inflation – but the loan is not (because it’s amortized), the loan amount stays the same in inflationary times while the value of the property increases.  This allows the property to loan ratio to be more and more beneficial to the investor over time.

To illustrate this fact; lets say that you buy an investment property for $1,000,000 and put 35% down. The $650,000 that you borrow is the hedge – because any increase in value is going to go in your pocket (the loan stays fixed or decreases).  As inflation devalues the dollar, the property value needs to be worth more dollars to be of the same value – but your loan is fixed amount so the payment stays the same, while the value of it decreases.  This allows your investment dollars to be unaffected by inflation.

In conclusion, there really are many benefits to purchasing investment property.  To find your first property or if your considering exiting an investment property, feel free to contact me.