In this chaotic world that we call home, everything can change with the flip of a coin. If these past two years have taught us anything, is that we must be prepared for anything and everything. The pandemic has had devastating consequences on the economy, that can still be felt today, including higher costs of living, rising interest rates, and inflation, just to name a few. But this has left a lot of us wondering what can we do to better position ourselves in case another pandemic hits or if the market crashes, or if you’re not a pessimist, just make more money.
Thankfully, there are a myriad of options at your disposal, everything from part-time jobs to side businesses, but none are more tried and true than investment properties.
An investment property is a real estate property purchased to earn a return on investment either through rental income, the future resale of the property, or both. The property can be held by an individual, a group of investors, or an LLC. Keep in mind that investment properties are not used as primary residences by the owner and they generate some form of income that fall outside the scope of the property owner’s regular line of business. Like with all other investments, choosing what to invest in and where can make all the difference.
So, the question remains, why should you consider an investment property?
Cash flow is the net income from a real estate investment after mortgage payments and operating expenses have been made. A key benefit of an investment property is its ability to generate cash flow. In many cases, cash flow only strengthens over time as you pay down your mortgage and build up your equity. Many people see this as a passive income, but before making this investment, you should work it all your expenses to ensure you will be receiving a consistent cash flow.
Tax Breaks and Deductions
Real estate investors can take advantage of numerous tax breaks and deductions that can save money come tax season. Generally, you can deduct the reasonable costs of owning, operating, and managing a property. And since the cost of buying and improving an investment property can be depreciated over its useful life (27.5 years for residential properties; 39 years for commercial properties), you benefit from decades of deductions that help lower your taxed income. But keep in mind that these taxes must be paid if you sell the property. Consult your CPA accountant for more details.
An investment property can be an incredibly flexible investment, whether you want a short-term or long-term investment, or you want to venture into the rental market, the flipping scene, or the leasing game, an investment property can do it all. However, you as the investor must choose which route you want to take. Residential rental properties are a hot commodity right now, as otherwise potential homebuyers, are now looking to rent. But, you must also withstand some negative cash flow if interest rates keep going up. Similarly, even with more long-term projects, like flipping a property, the upside potential is massive, but again, a property may not reach that potential in construction costs that go over the expected amount. These are all things one needs to consider; however, the choice is ultimately up to you, there is an investment property out there that meets your needs.
Real estate investors make money through rental income, any profits generated by property-dependent business activity, and appreciation of investment properties. Real estate values tend to increase over time, and with a good investment, you can turn a profit when it’s time to sell. Rents also tend to rise over time, which can lead to higher cash flow.
Build Equity and Wealth
As you pay down a property mortgage, you build equity. Equity is an asset that contributes to your net worth. As you build equity you can use that as leverage. Leverage the use of various financial instruments or borrowed capital, like debt, to increase an investment’s potential return. A 20% down payment on a mortgage, for example, gets you 100% of the house you want to buy—that’s leverage. Because real estate is a tangible asset and one that can serve as collateral, as financing is readily available. So as you build equity, you generate more leverage, giving you more opportunities and options to purchase investment properties.
Yet another benefit of purchasing an investment property is its diversification potential. The interesting thing about real estate is that it has a low, and in some cases negative, correlation with other major asset classes. Meaning, that the addition of real estate to a portfolio of diversified assets can lower volatility and provide a higher return per unit of risk. Simply put, diversifying your portfolio with real estate can lower your exposure to risk and greater returns.
Competitive Risk-Adjusted Returns
Real estate returns vary, depending on factors such as location, asset class, and management. Still, a number that many investors aim for is to beat the average returns of the S&P500. This is what many people refer to when they say ‘the market’. Historically, real estate investments have held up well even when the market has been volatile, hence making it the better investing option.
Despite all the benefits of investing in an investment property, there are drawbacks. One of the main ones is the lack of liquidity or the lack of cash on hand. Unlike a stock or bond transaction, which can be completed in seconds, real estate transitions can take months to close. But a good rule of thumb to follow is that you do not invest money you would need immediately.
Still, real estate is a distinct asset class that is simple to understand and can offer cash flow, tax breaks and deductions, flexibility, appreciation, building equity and wealth, diversifying your portfolio, and offer competitive risk-adjust returns. All in all, an investment property is a safe bet.