Investing in Residential Real Estate is one of the primary means of wealth accumulation in America today. For most Americans, investing in their own home is the largest investment they ever make. Extending that investment to other properties can be a means of building net worth.
There are five key characteristics that make real estate investing different from a passive investments such as the stock market:
INCOME: the property produces income in the form of rent, and that income can be used to pay for the investment itself. Because everyone has to have a place to live, the rental income tends to be more stable than the income from other investments. In addition, the income tends to rise over the course of time, as rent reflects the cost of ownership at the time of the rental. This benefits the owner, whose monthly cost is largely fixed at the time of acquisition.
DEPRECIATION: and other tax benefits are simply too good to be true. Many smart investors aim for a "break even" cash flow, but still get solid cash tax benefits from the tax shelter generated from depreciation. Investments can be exchanged without tax consequence, allowing the investor remarkable flexibility without any tax bill. And even if you sell, long term gains are not considered earned income, and therefore are not taxed by Social Security. The long term capital gains tax is currently at only 15%.
EQUITY BUILD UP: Equity in the property grows from the gradual pay off of the loan balance through amortization. Many investors choose a 30 year fixed rate loan program to keep their debt service costs to a minimum. Even so, as time passes, a larger and larger portion of the payment goes toward principal reduction. Eventually, the owner will own the property free and clear of any debt.
APPRECIATION: This increase in value can come from two sources, both from the economy (overall increase in value of real property) and from the improvements made by the owner (paint, carpet, adding a deck, mowing the lawn, etc.). Appreciation is the secret benefit of residential real estate, because the real money in owning real property is in holding it long term.
LEVERAGE: It only takes a small amount of cash to control a relatively large investment in residential real estate. Borrowing 80% to 95% of the purchase price is common, and locking in at a long term fixed interest rate is also common. In fact, if an investor has a good credit record, financing for up to 100% of the purchase price is often available. This type of leverage is typical in real estate because lenders believe the collateral (the real estate) is very stable in value. This leverage allows the investor to accumulate substantial dollar amount of investments relatively quickly. Also, owner financing is common, so investors with poor credit can get started as well.