Updated: Mar 6, 2019
The savvy investor wants to compare real estate investing with other forms like stocks, bonds, mutual funds, and ETFs. So what makes real estate investment so attractive in comparison? There are many factors that we are not going to get very far into today like historic stable performance or the tangible nature of real estate vs other assets. But, we will discuss these 4 points that really make real estate outshine some other investment options and next week we will do a quick case study on a simple "buy and hold" scenario.
1. Cash Flow
Sometimes referred to as "mailbox money", cash flow is the proceeds left over each month from a rental property after all of the expenses and financing has been paid. This is real profit that the owner can choose to use however they wish. The standard metric to weigh cash flow is called the "Cash-on-Cash" return (CoC). To calculate, take your annual cash flow divided by your amount invested, usually just the down payment (annual cash flow / down payment = CoC)
An exciting and often overlooked aspect of owning rental property is that your tenants are paying your mortgage! That means not only are they paying the interest, but also the principle, which can be pulled out during a refinance or sale of the property later on. Every month that the mortgage is paid using the tenant's rent, the owner is building equity in the property. This really adds up over time.
Appreciation is likely the most debated method of earning a return on an investment property. To truly appreciate, the value of the property must outpace inflation, which averages about 3% in the US. Real estate, however, is a physical, tangible asset, fully under your control in which you can "force" appreciation by making improvements, raising rents, and/or reducing operating costs. The market will truly determine how much appreciation you can expect, so this won't always be a positive return, think Detroit, Michigan during the 2008 recession. Put some thought into your market and demographic indicators and you can usually expect appreciation to at least match inflation and in some cases, exceed it.
"Uncle Sam wants you to own real estate." I think it was Robert Kiyosaki who said that first in his popular book, 'Rich Dad Poor Dad' and it holds true more than ever today. Depreciation is a big deduction you can make off of your income to significantly reduce your taxable income, without any more cash out of your pocket. Overall, real estate investments have many other unique tax advantages as well, such as the ability to deduct mortgage interest and all of the operating expenses. You can also utilize a 1031 exchange to fore-go capital gains tax at sale. We will visit those in more depth some other time.
Check out next week's post to see how we put these principles into play on a buy and hold scenario with a 20 unit apartment building.