Investing in real estate can be a great way to build tremendous wealth. However, it can also empty an investor’s bank account and leave them with debt. As with any investment type, there are risks. To help you figure out why is real estate a good investment for you, we’ve rounded up the pros and cons so you can make an informed decision.
Why is Real Estate a Good Investment?
You may be wondering why real estate is a good investment. There are many benefits, from earning monthly cash flow to building equity to tax deductions. Here are some reasons that make investing in real estate a good idea.
Pro #1: Leverage
One of the things that sets real estate apart from other types of investments is that you can use other people’s money (OPM) to buy it. Investors can borrow money to finance a property or multiple properties for a fraction of the total cost. Stocks and bonds don’t offer this benefit.
For example, let’s say you want to buy a $200,000 investment property to rent out to tenants. With financing, you’d put down 20 percent or $20,000, plus closing costs. You’re leveraging OPM (like a bank) to buy rental property to earn money through long-term appreciation and equity. Ideally, rent should cover your entire mortgage and then some. You can learn more about the 1% rule here.
Real estate investors can also leverage equity in their rental properties to pay for improvements and upgrades or to buy additional properties. In addition, investors have the option of doing a 1031 exchange where they swap one property for another like-kind property to avoid capital gains taxes.
Pro #2: Potential For Appreciation
Historically, home values have increased (along with inflation) over time. So unlike vehicles, which are depreciating assets, real estate is considered an appreciating asset. That said, appreciation potential will largely depend on where your rental property is located and that market’s potential for growth.
One of the reasons real estate is such a good investment is appreciation. You achieve this by buying an investment property in a good real estate market. While you can’t always predict appreciation markets, there are signs savvy investors pay close attention to such as areas with high job and population growth, affordability, and growing infrastructure. When a market shows these signs, rising home values often follow.
There are other ways for investors to “force” appreciation. This could be as simple as maintaining the investment property by consistently performing repairs and upgrades. For greater appreciation gains, investors can make more significant improvements over several years by adding or improving features that add long-term value and produce solid appreciation.
Pro #3: Rental Property Tax Benefits
Why is real estate a good investment? Multiple tax deductions! There’s a long list of tax benefits that rental property owners can take advantage of and these investment property tax deductions can include:
- Mortgage interest
- Depreciation
- Repair and maintenance costs
- Property management expenses
- Rental property losses
- Insurance
- Utilities
- Capital expenditures
- Appreciation taxes (When the property is passed down or inherited it will get a “step up” to fair market value and won’t be taxed on appreciation.)
Pro #4: Cash Flow / Passive Income
Is real estate a good investment strategy for generating passive income? Yes, especially for the long term. But that doesn’t mean a property won’t start producing cash flow in the short term. If you are purchasing turnkey rental properties, instead of rehabbing the property yourself, which usually takes a bit of time, you’ll be able to receive passive income as soon as the property has tenants.
One of the best ways to know if a property is a good investment is to crunch the numbers by meticulously analyzing and calculating all associated costs and expenses, including the mortgage. If you want to know more about this process, learn how to analyze a real estate deal here. You can also check rental rates in the area for properties similar to yours to give you a quick idea of how much you can realistically charge tenants for rent.
If your mortgage and total monthly expenses are less than your rental income, you’ve got a cash-flowing investment property!
If mortgage interest rates decrease in the future, refinancing the property at a lower rate will add to your monthly cash flow margins.
Pro #5: Builds Equity
Another reason why real estate is a good investment is that your tenants pay down your mortgage. This is basically free money, just in the form of equity. You may not have cash in your hand, but you’ll get the big payoff down the road. Think: kid’s college fund or retirement fund.
Real estate equity is unique because as your tenants pay down the principal mortgage amount over time, your property’s value should also be increasing. And, if you go with a fixed-rate mortgage, your monthly payments will stay the same for the lifetime of the loan.
Pro #6: More Stability & Control
Anyone who has invested in the stock market knows it can fluctuate daily. The stock market experiences more volatility because it’s impacted by a number of different economic factors and varying markets.
On the other hand, real estate is a good investment because it is much less vulnerable to significant fluctuations. This is especially true for buy-and-hold investors who want to hold real estate for the long term, as short-term dips in the market won’t affect the property’s overall profit.
Pro #7: Inflation Buster
Inflation raises the cost of goods and services and decreases the value of the dollar over time. Consider this: in 1987-1988, the average cost of tuition at a public four-year university was just over $3,000 per year (in-state residents). Today, the average cost of tuition is $9,750 per year (in-state residents).
While inflation may seem like a bad thing overall, property owners benefit from it. Why? Real estate is a physical asset, so appreciates along with the rate of inflation. A rental property is considered both a “good” and a service. This means when inflation rises, so do monthly rents.
Borrowing money to buy real estate can be an excellent way to make inflation work for you. If you finance a property with a 30-year fixed-rate loan, your monthly mortgage payment will always stay the same. Over the next several years, your property will have appreciated and your mortgage will have depreciated. Essentially, inflation eats away at debt, which makes real estate a great inflation-fighting investment strategy.
Pro #8: Diversification Lowers Risk
One of the fundamental rules of investing is to diversify. A well-balanced portfolio is key to minimizing overall risk and should include a variety of investments across multiple industries. Another reason why real estate is one of the best investment strategies is that this asset class isn’t directly impacted by stock market fluctuations. So having a mix of traditional investments and rental property will help lower your risk.
Is Real Estate a good investment? The cons.
Now that we’ve examined why real estate is a good investment, let’s discuss the risks. All types of investments come with a certain amount and it’s best to invest based on your risk tolerance. For example, some bonds and CDs, have a lower risk, which is good, but on the flip side, the returns are also low, not so good. Before deciding why real estate is a good investment for you, let’s weigh the potential cons.
Con #1: A Chunk of Money (Usually)
While financing makes it more affordable to buy an investment property, you’ll still need a good amount of cash upfront. For a down payment, you’ll typically need 20 percent to 25 percent of the purchase price. There are also closing costs and funds needed for any initial repairs and updates you want to make to the rental property. Then, there are ongoing expenses like insurance, mortgage payments, property taxes, maintenance, and property management (unless you choose to be your own landlord). For many investors, that may be too much money to put into a single investment.
Con #2: Time / Learning Curve
Learning the ins and outs of real estate investing can take a lot of time and discipline.
I’ve been in the real estate industry for years, and there is still plenty to learn. Before pouring a whole bunch of money into an investment property, it’s important to understand real estate terminology and become somewhat knowledgeable about basic investment strategies.
If you want to invest in real estate but don’t want to flip or BRRRR, you may want to consider turnkey investing. With this approach, the idea is that you purchase a rent-ready rental property and have a property manager or management company manage the property. This method allows busy people to build a portfolio while continuing to work at their job or following other pursuits.
Keep in mind, that not every turnkey real estate company has the same idea of “rent-ready” so do your due diligence. If you decide to go this route, please join RealWealth to get free access to our education and resources, and thoroughly vetted turnkey property teams with proven track records.
To expedite the learning process, connect with real estate experts and talk with your financial advisor. Finding a quality real estate mentor might take some time, but it’ll be well worth it in the long run.
A great way to level up your knowledge is to listen to The RealWealth Show podcast. Host Kathy Fettke, my wife and RealWealth Co-Founder, and expert guests share insights on real estate investing strategies and more.
Con #3: Longer Wait For Returns
We’ve already covered why is real estate a good investment for the long term. What about those looking for short-term returns or the option to access cash quickly? If that’s what you are looking for, real estate might not be the best option for you. As I said before, it is possible to start seeing returns in the form of rental income sooner than later. But it’s fairly uncommon for a rental property to see significant gains in a short period.
There are short-term real estate investment strategies, such as vacation rentals and mid-term rentals, but they can be more challenging to execute successfully, especially for newer investors. As you consider your real estate investing options, be aware that types of short-term strategies inherently come with unique risks and challenges.
Con #4: Tenant Challenges & Vacancies
Whether you’re personally managing the rental property or not, tenants bring their own set of challenges and added costs. Experienced landlords and real estate investors know the importance of finding and keeping quality tenants. Quality tenants are worth their weight in gold because they tend to stay long-term and take pride in your property as if it were their own. But, they can be hard to come by.
Vacancies are another risk factor with owning rental property. Every month your property sits empty, you are losing money out of your own pocket. Additionally, the average cost of tenant turnover is around $2,000 per rental unit.
Hiring a property management company can save investors a lot of time, stress and money.
Con #5: You May Not Qualify for All Tax Benefits
Is real estate a good investment because of all the tax breaks? Yes, but it depends on your annual income. High net-worth investors fall into a higher tax bracket, which limits their ability to make certain deductions. Before investing, it’s always wise to consult a CPA to make sure you know exactly what deductions you can apply.
Con #6: More Liability
Owning an asset that people live in creates more liability risks. If an accident occurs on your rental property, you will be held liable. Rental property insurance will mitigate much of that risk, but won’t eliminate it entirely. Shop around before deciding which insurance policy works best with your risk tolerance.
Con #7: Over-leveraging
A common mistake many real estate investors fall into is getting over-leveraged. This happens when an investor over-borrows or carries too much debt compared to the property’s cash flow and equity.
Even if the market tanks, property owners are still responsible for paying the mortgage and any associated expenses. Investors who are over-leveraged for a long period are exposing themselves to potentially huge losses.
It’s important to avoid over-borrowing and have a hefty emergency fund to offset some of the risk.
Con #8: Fewer Exit Strategies
Selling an investment property takes time and money, making real estate one of the least liquid investments available. The transaction costs and fees to sell a property can get expensive, and unless you get a cash offer, the financing process can take between 30 and 60 days.
There’s always a chance that the market will be slow when you decide to sell, making it harder to do so, at least at the price you want. Owning a property that you can’t sell and isn’t producing income is a big risk and can quickly drain your nest egg.
If you’re looking for flexible and fast investing options, you might consider sticking with stocks as we can now buy and sell stocks with a simple click of a button.
Should I Invest in Real Estate?
If I haven’t scared you off and you’re still pondering why is real estate a good investment for me, here are some tips on how to get started.
1. Decide Which Type of Properties You Want to Invest In
A great way to get into real estate is to invest in a duplex and live on one side while renting out the other. This investment strategy is known as house hacking and is totally doable for beginners. There are a few major advantages to house hacking, including lower housing costs and growing equity. The idea is that tenants would pay all or a significant portion of your mortgage while helping build equity in your property at the same time. If there is extra monthly cash flow, you can put that in your retirement fund or save for a future investment property.
2. Assess Your Financing Options
If you are considering buying an investment property with cash, I would recommend thinking long and hard about whether you want to put that amount of money into one asset. Even if you can buy a property outright, that may not always be the smartest investment strategy and may disqualify you from certain tax deductions.
Financing a real estate investment at a low interest rate should steadily increase your monthly cash flow and profit margin. And because we know that inflation eats away at debt, it often makes more sense to take out a low-interest, fixed-rate mortgage.
3. Research Local Housing Markets
The health of local housing markets across the country varies, so research and analyze the best places to buy rental property. Be sure to look at local markets and out-of-state markets, and not just focus on national trends. If you need guidance on where to start, check out RealWealth’s curated list of the top real estate markets for investors.
4. Learn From Others & Educate Yourself
There is an endless supply of free real estate investing education available that can help you answer the question, “Is real estate a good investment for me?” Educate yourself and learn from others by reading articles, listening to podcasts, watching webinars, or joining investing groups.
If you are ready to learn all you can, so you’ll understand how and why is real estate a good investment strategy for your goals, join RealWealth. Membership is 100% free, yes free, and gives you access to educational content, investor resources, turnkey property teams, and an investment counselor who is here to help support you.
Final Thoughts: Is Real Estate a Good Investment?
For many investors, investing in rental property can be a great way to generate passive income and build wealth. Whether your financial goals are to save for retirement, a college fund, or become financially independent, investing in real estate has proven to be an excellent vehicle to build wealth.
