Are you considering investing directly in rental real estate? With many people increasingly concerned about both stock
market valuations, you’re not alone. First, let’s take a look at some of the benefits of becoming a landlord:
Income: With stocks and bonds both yielding about 2%, one of the main benefits of real estate is the ability to generate significant income without having to sell your investment. It’s possible to generate high single to low double digit returns on your cash even with a mortgage.
Inflation protection: Not only can real estate provide good income, it’s income that naturally keeps pace with inflation. Inflation can also increase the value of real estate and reduce the real burden of mortgage debt over time. For these reasons, it can be a great way to hedge against the possibility of rising inflation, which generally hurts both stocks and bonds.
Historically, real estate appreciation plus rental income has underperformed
stock appreciation plus dividend income. What gives real estate an advantage is the ability to benefit from the leverage of purchasing it with borrowed money at relatively low interest rates. For example, if you put down 20% on a $100k property and it appreciates 3%, you actually earn a 15% return ($3k of appreciation divided by the $20k you put down). Of course, you can buy stocks on margin but margin rates are higher and are not tax deductible. You could also be forced to sell your stocks while they’re low to satisfy a margin call.
Real estate also comes with a lot of tax advantages. First, you can deduct costs such as the mortgage interest, property taxes, and depreciation from your taxes and even use excess “losses” to reduce your other taxes. If you sell a property, you can defer
the capital gains tax by reinvesting the proceeds in another one. When you pass away, your heirs can inherit the property and sell it without having to pay any tax on all the appreciation during your lifetime.
Control: You can add additional value to real estate by purchasing a property you believe will appreciate faster than the overall market (the real estate market is much less efficient than the stock market so there are more opportunities to profit from superior knowledge), making improvements, and managing it yourself.
However, real estate is not for everyone. There are some important challenges to be aware of too. Before taking the plunge, here are some questions to ask yourself: