Ten Reasons Why Real Estate is a Superior Investment
Do you have enough money saved for retirement? Financial planners usually use the “25 Times Rule” to determine how much a portfolio should be worth for someone to safely retire. If you need $50,000 a year to live on when you retire, then, using the “25 Times Rule” you should have $1,250,000 in stocks, bonds and mutual funds. Then, at retirement, financial planners begin liquidating these assets using a “4-Percent Rule,” which simply means they liquidate 4 percent of the portfolio each year until it is down to zero after 25 years. If you retire at 65, you better hope you don’t live past 90 or you’ll be broke.
Compared to investors who rely on the stock market to accumulate assets for their retirement, real estate investments take a different approach. If you accumulate $2,800,000 in income-producing real estate it will pay $50,000 a year in income and continue to appreciate in value over the years, not only covering you indefinitely but also leaving you something to pass on to your children.
Here’s the interesting part, it only takes $700,000 in investment capital to accumulate $2,800,000 in real estate assets. By comparison, it takes about $900,000 in stock investments to achieve a $50,000 per year annual income, assuming that during 30 years of investing both types of investments yield a 4 percent return.
Real Estate has many advantages over investing in stocks, bonds or mutual funds. Real estate offers predictable cash flow; it appreciates in value, thus keeping up with inflation; it provides a higher return because of positive leverage; and it offers equity growth through debt reduction. During retirement, real estate is a self-sustaining asset while stocks are a self-liquidating asset. Which would you prefer, a self-sustaining asset or a self-liquidating asset?
Ten reasons to invest in real estate:
1. Real estate has a predictable cash flow
Cash flow is the net spendable income derived from the investment after all operating expenses and mortgage payments have been made. A good real estate investment should provide you with 6% or greater cash flow.
2. Real estate appreciates in value
Since 1968, appreciation levels for real estate have been 6 percent per year, including during the downturn in the economy beginning in 2007, according to the National Association of Realtors.
3. Real estate can be leveraged
The most important advantage of real estate investing is LEVERAGE! It is the use of borrowed capital to increase the potential return of an investment. In real estate transactions, leverage occurs when a mortgage is used to reduce the amount of investor capital required to purchase a property. The annual return on a $200,000 property with a $20,000 net cash flow purchased with cash is 10 percent. If 75% of the money required to purchase the property is borrowed, even factoring in the cost of making the mortgage payment, the annual return more than doubles to 22 percent (assuming a loan of $150,000 is amortized over 30 years at 5 percent interest).
Once you have built up an equity position in an investment property, you can leverage that investment for cash in one of two ways: Secure a second loan against the increased equity or refinance the original loan amount plus the increase equity.
4. Real estate provides equity buildup
Most real estate is purchased with a small down payment with the balance of the money being provided through debt financing from a lender. Over time, the principal amount of the mortgage is paid down, slowly at first, and then more rapidly toward the end of the amortization period. This principal reduction builds equity.
5. Real estate is improvable
One of the most unique and attractive advantages of real estate is that it is improvable. Because real estate is a tangible asset made of wood, brick, concrete, and glass you can improve the value of any property with some “elbow grease” and “sweat equity.” Whether the repairs are structural or cosmetic, do it yourself or hire someone, the principle is the same.
6. Real estate coincides with retirement
When real estate is purchased, the cash flow is lower and the principal reduction on the mortgage is less. Over time, the mortgage is paid down, or paid off, and the cash flow increases. In some respects it’s a forced savings program, yielding a greater amount as time goes by which is a perfect investment for retirement as it increases in cash flow down the road.
7. Real estate is tax deductible
Tax codes allows various deductions for the normal expenses incurred in owning real estate, such as property upkeep, maintenance, improvements and even the interest paid on the mortgage. The deductions can offset income and reduce your overall taxes.
8. Real estate is depreciable
Depreciation is a non-cash expense permitted by the tax code that depreciates in value of your investment property over time. However, the value of your investment property actually appreciates. The depreciation deduction allows a real estate investor to generate a larger positive cash flow while reporting a lower income for tax purposes. This creates a higher return than you may initially realize.
9. Real estate has a lower tax rate
If your investment property is sold after a year, the gain is subject to capital gains tax rates which depending upon your individual tax bracket is generally 15% or 20% which is usually less than ones personal tax bracket.
10. Real estate gains are deferrable
Our tax code, under a 1031 exchange, permits the gain on the sale of an investment property to be transferred from the property being sold to a new property being purchased, hence deferring the payment of any tax on the sale of the property.
There is one final advantage to a real estate investment and that it is understandable and easy for most everyone. It’s easy to purchase, it’s easy to finance and there are no insurmountable financial barriers to entry. It’s easy for most investors to improve their properties and it’s easy to use the tax advantages. While Wall Street is becoming more and more of a mystery and becoming the game of financiers, real estate investing is looking better and better.
Unleash the Investing Power of a 401(k)
For years, the primary retirement plan was a company pension plan. At retirement, a retiree would receive a fixed sum, or a pension, paid by the employer. By offering a superior pension plan, employers, the government and labor unions attracted good employees. Unfortunately for the employers, no one counted on life expectancies to increase by nearly 20 years, which has caused most large pension funds to be seriously underfunded. Some companies have chosen bankruptcy rather than pay the pension benefits promised to retirees.
Companies are quickly replacing pension plans in favor of a 401(K). This program means employers no longer have to pay pensions, though some employers match employee contributions up to a certain amount. In 2014, the annual amount an employee can contribute to his/her 401(K) account is $17,500. If you are 50 years old or older, you can contribute an additional $5,500 as a catch up contribution for a total of $23,000 per year. Any matching contributions your employer makes to your account are added to the amount you can contribute, up to a maximum of $51,000 per year.
Employer based 401(k) programs are a great start. However, instead of putting all your retirement funds in your employer’s 401(k) program, which only allows you to invest in a selected number of stocks, bonds and mutual funds, you can also start your own Individual IRA account with a Self-Directed Administrator/Custodian such as PENSCO*. You can direct your money into Income-producing real estate, which is a far better investment than putting your money in the stock market (see the article, “Ten Reasons Why Real Estate is a Superior Investment” in November 2013 Jacksonville Review or on our blog at expertprops.com). You can transfer your existing 401(K) into a Self-Directed IRA, which opens up the possibility of investing even more into income-producing real estate, or you can start a new IRA that is self directed.
The ins and outs of self directed IRA’s:
Investment Choices for Self-directed investors
- Real Estate: (Rental property, Commercial, Raw Land, Boat Slips, Mortgages)
- Private Equities: (Invest in a LLC, Private Stock, Convertible Notes, Private Hedge Fund)
- Promissory Notes: (Secured notes like real property or unsecured notes)
- Other Alternative Assets: (Publicly traded foreign currencies, Precious Metals)
- All investments grow tax-deferred. If held by a Roth IRA, your capital gains and interest earned are tax free. Because in most cases, you are not taxed until retirement in a tax-deferred account, your return on investment can accumulate faster, and that accumulated return may be reinvested tax deferred.
- Diversification is a way to reduce risk in your investment portfolio, “Don’t put all your eggs in one basket
You’re in Control
- As the term “self-directed” suggests, you or someone you appoint makes all the investing decisions – what to buy, how to buy it, when to sell, to leverage or not to leverage.
- You can’t hold the property in your name it must be in an IRA’s name
- All expenses and revenue must go through the IRA
- NO personal use of the property is allowed.
- Maintenance and repairs must be done by a third party
- You can’t take out the money until you’re 59 ½ years old.
- You can have partners, Tenants in Common, Limited Liability corporation (LLC)
- You can leverage to increase your yield by getting a non-recourse mortgage loan or the seller can carry-back a loan. (see IRAlending.com)
- Investments can be held in a traditional IRA, Roth IRA, SEP-IRA, Solo (k) or 401 (k)
We mentioned above that you can leverage your investment to increase your yield and here is how that works. You invest $100,000 in mutual funds and $100,000 in real estate both of which are appreciating at 6% a year. The only difference is that you can borrow additional money from a bank to buy more real estate, and leverage your investment. Say you obtain a 20 year amortizing loan at 5 percent. You borrow $300,000, so you have $400,000 to invest total. After 20 years, your mutual fund investment has increased 6% yearly to $320,714, while your real estate investment has increased 6% yearly to $1,282,854. This is $962,140 more than the same investment in mutual funds, and a 300 percent increase in value with the same $100,000. That’s the power of real estate and the power of leverage.
The 20 years of mortgage payments have been covered by your tenant but you get all the appreciation and the tax benefits of the depreciation and interest write offs.
It is a lot to consider but we have done this for ourselves and a number of clients. Give us a call, and we’ll show you how to do it 541-899-7788.
For additional information go to Pensco.com and read the ABC’s of Self-Directed IRA’s.
*PENSCO Trust Company
It is very rewarding helping our investors acquire foreclosures at below market prices, helping to renovate them and rent them out or sell them for a profit. We have great expertise in helping our investors earn high yields on their investments. We specialize in capital preservation, maximizing cash flow and appreciation. Below you will find one example of some of our investors who have profited from this strategy.
Case Study #1