7 Ways Real Estate Generates Wealth - Part 2
In Part 1 we looked at the first three ways real estate generates wealth with a comparison to stock market investment: #1 - Cash Flow, #2 - Appreciation, #3 - Loan Pay Down. Our example used a $100,000 investment over a 5 year period and demonstrated that real estate investment can yield returns over 275% greater than the stock market.
Let’s review the four other advantages that real estate investment for wealth generation: #4 - Forced Appreciation, #5 - Leverage, #6 - Tax Advantages, #7 - Tangible Asset.
Wealth Creation Stream #4: Forced Appreciation
The easiest way to explain forced appreciation is to use the example of flipping houses. It is investing in improving the property to create more value in the property than the investment made. This can be as easy as spending a couple of thousand dollars on cosmetic improvements to get an additional $5000 on your sale price. Done in the right market conditions, forced appreciation can significantly improve your returns and one of the big benefits in real estate when comparing to the stock market is that you can control the asset.
Wealth Creation Stream #5: Leverage
I love leverage!!!!!!!! This is one of the key advantages of real estate investment that people often do not realize. In the stock market, if you want to buy $100,000 worth of stock, you need to personally invest $100,000. However, in real estate, banks feel that real estate is a lower risk investment in their portfolio so in most cases they will only require you to put 20% for a down payment. So you if you put $100,000 into real estate investment you can purchase a property worth $500,000. That is the power of leverage, you invest $100,000 and you receive a loan for an additional 80% of your investment. The interest on this loan is paid by your renters. As your property value increases and your loan pays down, you have the leverage to buy additional properties further increasing your wealth. Your investment properties has babies that result in more revenue streams!
Wealth Creation Stream #6: Tax Advantages
As Benjamin Franklin said, “nothing is certain but death and taxes”. This is certainly true and there is no way to avoid it. Everyone has a different tax situation and should consult their accountant to see what tax benefits would apply to them. There a number of ways that real estate investors may have tax advantages:
i. Deductions: The basic advantage is the ability to deduct normal operating expenses associated with the property such as property taxes, mortgage.
ii. Amortization: In Canada, if you own a property that is income producing, you may be able to amortize the purchase price at 4% per year.
iii. Capital gains taxes instead of income taxes. In Canada, you pay tax on 50% of any capital gains you realize.
iv. Depending on how the financing is set up and your tax situation it is may be possible to roll the money from the sale of the property into a new property within a certain time period. This is how wealthy people really scale their investments and avoid capital gains and amortization recapture during high income years.
Wealth Creation Stream #7: Tangible Asset
Real estate is a tangible, hard asset. Hard assets have a unique ability to hedge against inflation and real estate is even more unique than other hard assets because it has the ability to generate cash flow. As well, hard assets hold an intrinsic value in that they are a physical asset and not paper or virtual. Assets with intrinsic value such as real estate, gold, silver, oil, etc. are naturally in limited supply, you just can’t print them out of thin air and they can be used to buy needed goods and services or traded in return for goods and services. It is this intrinsic value held by hard assets that make them good to hedge against inflation. As well, when you buy real estate, you essentially have two hard assets, the land and the structure because they both are in limited supply and they both serve basic human needs. Stocks and bonds are examples of “soft assets”. It is harder to maintain your investment dollars with inflation because they will usually lose value as the Consumer Price Index increases. See our article “The Best Way to Hedge Your Investments against Inflation – Real Estate Investing!” to learn more about how hard assets are a great investment.
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