Related AccountingTools Courses
- Real Estate Accounting
- Real Estate Investing
- Property Management Accounting
Advantages of Real Estate Investing
1. Real Estate Can Be Purchased at Below-Market Prices
With a keen understanding of local market prices, it is sometimes possible to acquire real estate below market value. Sellers in urgent need to sell may offer attractive deals, especially to buyers with ready cash.
2. Real Estate Generates Steady Cash Inflows
Rental properties provide a consistent stream of income from monthly rent payments. Additional revenue can come from amenities like washers, dryers, storage, and parking. Properly managed properties can yield substantial net cash inflows after covering expenses such as mortgage payments, taxes, and maintenance.
3. Real Estate Provides a Depreciation Tax Shield
Depreciation expense on real estate investments reduces taxable income without actual cash outflow, offering a tax shield. The current depreciation period is 27.5 years for residential properties and 39 years for commercial buildings.
4. Real Estate Appreciates in Value
Over time, real estate tends to appreciate, especially in high-demand areas. Skillful property improvements can also significantly increase property value.
5. Real Estate Provides an Inflationary Hedge
Real estate typically appreciates faster than inflation, making it a reliable hedge. Investors often bid up real estate prices during high inflation periods, viewing it as a safe investment.
6. Real Estate Financing Creates Leverage Benefits
Real estate purchases are often financed with substantial mortgages, amplifying returns on the invested capital. For example, a $50,000 down payment on a $300,000 property yielding $25,000 annually results in a 50% return on the down payment.
7. Real Estate Defers Taxes
Income tax on property value increases is deferred until the property is sold. Current tax laws allow rolling over gains into new real estate investments, potentially deferring taxes indefinitely.
8. Real Estate Income Gradually Increases
Fixed-rate mortgages mean that rental income can increase with inflation, improving the return on investment over time.
9. Real Estate Allows for Active Investment Control
Unlike passive investments in stocks or bonds, real estate investors can actively manage their properties, influence costs, choose tenants, and decide when to sell, giving more control over returns.
Disadvantages of Real Estate Investing
1. Real Estate Investing is a Long Grind
Significant returns typically accrue over extended periods, requiring judicious purchasing and property maintenance. Active property management may preclude vacation time.
2. Real Estate Income Can Be Variable
Income can fluctuate, especially with high mortgage payments and periods of low demand or non-rental. Properties in areas dependent on a single employer are particularly vulnerable.
3. Real Estate Requires Maintenance
Unexpected maintenance issues can incur substantial costs, depleting cash reserves. Proper property inspections and maintenance plans are crucial.
4. Real Estate is Impacted by Rent Control
Rent controls can limit the ability to raise rents, potentially reducing profitability. Requests for rent increases may be granted only grudgingly.
5. Real Estate Requires Your Time
Investing in real estate demands significant time for learning markets, identifying investment opportunities, and managing properties. Hiring a property manager can help but still requires oversight.
6. Real Estate Transaction Costs are High
Buying and selling properties involve high transaction costs, including commissions, title insurance, and closing costs, which can erode appreciation gains.
7. Real Estate Income is Subject to Taxation
Ongoing income and gains from property sales are subject to federal and state taxes, which can be substantial.
8. Real Estate Values Can Decline
Property values can decline sharply, particularly following market bubbles. Buying near peak prices with modest down payments can result in significant losses.
9. Real Estate Rents Can Decline
During economic downturns, finding quality tenants can be challenging, leading to potential non-rental periods and financial strain.
10. Real Estate Leverage Effects Can Be Negative
Leverage magnifies both gains and losses. Significant losses can occur if property income fails to cover debt obligations.
11. Real Estate is Not Liquid
Selling real estate quickly can be difficult, especially under financial duress, potentially leading to significant losses.
Mitigating Disadvantages
To mitigate these disadvantages, hold properties for extended periods, maintain a cash reserve for negative cash flow situations, and roll gains from property sales into new investments to defer taxes.
Key Real Estate Investing Metrics
1. Net Cash Flow
Project and net cash outflows and inflows to determine the net cash expenditure or receipt.
2. Net Operating Income
Subtract operating expenses from rental income to determine net operating income.
3. Rate of Return
Divide net operating income by the property purchase price to determine the percentage rate of return.
4. Total Return
Calculate total cash profit from property sales, plus all net cash flows, minus the mortgage balance payout to determine total return on investment.
Alternatives to Real Estate Investing
For those lacking time, investing in a real estate investment trust (REIT) offers a more passive approach. REITs operate real estate properties and distribute income as dividends to shareholders.
Summary
Real estate remains one of the best investment options, given careful research and long-term holding. Economic conditions and the need for personal involvement can influence success, but the potential rewards of real estate investing can be significant.
0 Comments