Participate to Control
Real estate allows you to control your risk because you can actively participate in the decision-making process. Passive investments such as stocks don’t give you this opportunity. Movements in real estate values are less erratic than in the stock market. Most people don’t understand the economic forces influencing the market. Since real estate is less volatile, it’s easier to control and to understand. Real estate is tangible. You can touch it, you’ve been exposed to it all your life, and you can identify with it. As a result of this familiarity, you are better able to understand it.
Effectively Reducing Your Taxes
Real estate ownership continues to be the most popular form of investment because of its potential for substantial tax savings. Since you are able to actively participate in the management of real estate, the Internal Revenue Service (IRS) currently allows qualifying individuals to write off up to $25,000 per year against salary and other income. No other investment gives you this capability. In addition, you can defer paying income taxes on profits indefinitely by using tax-deferred exchanges.
Leveraging That Works
Real estate is the only major investment that gives you the ability to acquire ownership with very little money down. This degree of leveraging allows you to amplify profits by using other people’s money. The more assets you are able to control, the more opportunities you have to succeed. The degree of leverage is calculated by dividing the total purchase price of the property by the amount of funds used to purchase it. Thus, if a down payment of $10,000 plus a $90,000 loan is used to purchase a property, a 10 to 1 leverage ratio has been achieved. The greater the leverage, the more equity will increase or decrease with the change in value of the property.
Three Advantages of Rental Income Property
Rental income property should remain well ahead of other major property types because they are generally more stable. Three important factors account for this stability:
- They are less dependent on business cycles for occupancy than any other types of real estate investments. It doesn’t matter if interest rates and home prices are high or low, rental income property are generally more affordable.
- Rental income property have shorter leases; thereby offering greater protection from inflation than the long-term leases associated with other properties. That is, rents can be negotiated more frequently.
- The pool of tenants is much greater for rental income property than other types of properties. This ensures a more consistent occupancy than industrial and commercial properties, which usually have only a few tenants to choose from.
The Building Size That Gives You the Greatest Profit Potential
When investing in residential income properties, try to find the right building size that makes the best use of your time and gives you the greatest profit potential. Single-family houses and small apartment units do not always work because of competition and property management problems. Managing property on a day-to-day basis may not be for you. You could spend just as much time on a four-unit building as on a 40-unit complex and not make nearly as much money. Larger units are the domain of the institutional investors, and you can’t compete with their availability of funds. After making many property transactions, you may find, as we did, that mid-size rental properties are the right niche.
The Coming Bonanza for You
Supply and demand play an important role in residential income property value. The demand for rental property is increasing because the number of people entering the rental market is increasing steadily each year. At the same time, construction costs, stricter zoning ordinances, and environmental factors are limiting the new construction of residential income property. Together, these trends bode well for investing in residential income property.
Because the 1997 tax act allows joint owners to exempt capital gains of $500,000, more and more people are selling their homes, saving their money, and moving into rental property. It is estimated that the demand for rentals is likely to increase over 10 percent during the next 10years. Residential income property offers one of the best protections against inflation. In fact, a study reported by the Journal of Financial Economics found that residential real estate is the only investment that offers a complete hedge against both anticipated and unanticipated inflation.
The Shock Absorber
Real estate generally outperforms equities because of its higher yields, greater price stability, and downside protection even in a recession. When stock markets are down, real estate holds value and produces a positive return. Real estate is less prone to booms and busts than in the past. Residential income-producing real estate is now stronger than it has been in many years.
Since rental income properties can be seen and touched and are not an abstract form of ownership, they are investor friendly. People can identify with doors and windows, bedrooms and bathrooms, and floors and roofs. They don’t feel that the market is being manipulated by programmed buying and selling. They have more control over their investments.
Shelter is one of the basic necessities of life. There will always be a need for housing. And midsized rental income property fit the bill.
ABOUT THE AUTHOR: Eugene E. Vollucci, is considered to be one of the foremost authorities on real estate taxation and apartment investing and has authored four books in these fields. He is the Director of the Center for Real Estate Studies, a real estate research organization. To learn more about the Center for Real Estate Studies, please visit our web site at http://www.calstatecompanies.com