Many people have decided that real estate is a powerful tool to accumulate wealth. Some believe it’s the only tool. Many of those investors have been successful at it. Like all markets, the Real Estate market goes up and down. So, what is so special about owning real estate?
When talking with investors and professionals who work with them, a few consistent themes emerge as to why they’ve decided on real estate investing:
- Substantial tax benefits. There are many sections of the tax code of which real estate investors regularly take advantage. They can defer (and sometimes avoid) capital gains tax on appreciated property. Any losses incurred can offset future capital gains, and those who are designated Qualified Real Estate Professionals can avoid the loss carryforward rules that often limit or delay the benefits of a substantial tax loss. They can use depreciation and other expensing techniques such as cost segregation to limit their exposure to income tax. As with most sophisticated tax planning techniques, this should be completed with the guidance of a skilled tax professional in order to properly execute without running afoul of the IRS.
- The power of leverage. Investors who use debt to finance their deals, utilize someone else’s money to acquire their properties. Once acquired and occupied, the rents received provide the money to service and retire the debt. Properly structured, real estate investors can acquire large assets using a relatively small amount of their own capital.
- Potential for long term appreciation. While rents are covering debt services and providing income, the long-term growth in the value of real estate assets can add substantial value to an investor’s balance sheet.
- Passive cash flow. Properly structured real estate investments can generate income streams independent of an investor’s daily effort. With enough properly designed assets in place, consistent cash flow can be generated by the investor.
- Inflation protection. Every financial plan must address inflation. Real estate values tend to rise with inflation. Investors can include rent elevators in their contracts to ensure their income streams keep pace with inflation. This can offset the impact of inflation. Successful investors must understand if a particular market has inflated over time, and whether it is likely to do so over time.
- It’s Tangible. After living through decades of boom and bust stock and bond market cycles, many concluded that they wanted tangible investments. Real Estate investors can touch their investments – be it a house, apartment complex, warehouse, or office building.
This list is not comprehensive, but the themes are quite common. It should be noted, that real estate is not a silver bullet that helps achieve all financial planning objectives.
In fact, for many of the concepts above, there are risks against which these strategies must be measured. For example, using leverage as described adds potential risk to an investment. Without the means to handle higher than anticipate vacancy rates or carrying costs, new investors might suffer financial harm. While real estate tends to appreciate over time, market bubbles do occur. Real estate tends to be illiquid, so investors may not have access to their capital for some time. It is important to understand how these risks may impact an investor’s long-term plan.
Like all people, real estate investors arrive at financial crossroads in their life. At points such as those, they would benefit from a comprehensive understanding of their finances. Investors may come to a point where they are financially independent and want to plan for their family’s legacy. They face issues of protecting their assets from avoidable taxation, while also protecting their family from the pit-falls of inherited wealth.
Others may be less interested in leaving a legacy but want to unburden themselves from the management of their portfolio. While the IRS has provided a great advantage in accumulating these assets, the bill comes due when it’s time to sell.
Many mid-career professionals embark upon real estate investing to free themselves from their 9 to 5 job. It’s important to have clarity about the cash flow and return expectations they need to meet to replace their paycheck, which assets to deploy, and what risks they deem prudent in this endeavor.
When determining the best direction at these stages in life, investors are well served by seeking competent counsel from Financial Planning Professionals, as well as Attorneys, and Accountants who understand the unique opportunities and challenges real estate investors face.
David Ellowitch, CFP ® is the Managing Member of Ellowitch 3, LLC, a Financial Services Firm with offices in Allentown, PA and Paramus, NJ. He is a registered representative of Lincoln Financial Advisors Corp., a broker/dealer (member SIPC) and registered investment advisor. Ellowitch 3, LLC is not an affiliate of Lincoln Financial Advisors Corp. CRN-2699557-082319