Leverage, Just One of the Benefits of Real Estate Investing
Real estate has the ability to leverage an investor’s capital, meaning an investor who buys real estate does not have to pay all cash to purchase the asset. Investors in gold have to pay all cash when buying gold.
Banks will lend at least 75 percent of the money required to purchase a real estate investment. In using the bank’s money, an investor leverages his investment by putting down a small down payment and borrowing the rest of the money to acquire the property. With positive leverage, an investor can actually supercharge his or her return because the entire property appreciates in value not just the cash invested.
Equity and Cash Flow from Real Estate
From 1994 through 2013, gold had an annual appreciation rate of 6.51 percent. During the same time period, a real estate investor who bought an average-price new home for $154,500 put down 25 percent equity of $38,625 and paid interest of 5 percent on a 30-year amortized loan would have had an annual return on the appreciation of his capital investment in the home of 7.64 percent.
Another benefit of income-producing real estate is that while the tenant is paying rent, which goes to pay the monthly mortgage payments, the debt on the property is reducing. An average new home that cost $154,500 in 1994, based on a 75 percent loan-to-value ratio, would have a mortgage of $115,875. Over the next 20 years, the principal loan balance would be paid down to $58,647. The tenant, by paying rent, would have paid down the mortgage balance by $57,228. The increase in equity from the reduction in the principal balance of the loan was paid by the tenant’s rental payments. When combining a 5 percent cash flow with equity buildup and appreciation over 20 years, the overall return on this modest real estate investment would be 10.79 percent; a whopping 4.28 percent higher return than an investment in gold!
Tax Benefits of Real Estate
Besides cash flow, leverage, equity buildup and appreciation, a real estate investor also experiences favorable tax benefits while owning real estate. Although real estate actually appreciates in value, for tax purposes, the government permits an investor to depreciate the asset over either 27 ½ years or 39 years, depending on whether the property is residential or commercial. This tax break enables the investor to shelter most of his cash flow without having to recognize it as income. Additionally, when a real estate investment is sold, the gain on the sale is taxed at a 15 percent rate, depending on the investor’s adjusted gross income.
Gold is taxed at 28 percent. Gain from the sale of gold is considered collectibles gain and is taxed at a higher rate than conventional long-term capital gains. The maximum tax rate on collectibles gain is 28 percent.
Real Estate Is More Stable
Although gold is more stable than stocks, it is still more volatile than real estate. Over the past 40 years, gold experienced a decline in value in 15 of the past 40 years. Those declines ranged from a low of -0.05 percent to a high of 25.2 percent in one year. During several years, gold declined more than 10 percent in value. Real estate, on the other hand, experienced declines in value in only five of the last 40 years. Those declines ranged from a low of 1.74 percent to a high of 7.42 percent. Real estate is unquestionably less volatile than gold.