Tuesday, December 4, 2012

Why Real Estate is the Best Investment

11:45 AM

Why Real Estate?

Remember the four components to real estate investment: Appreciation, Depreciation, Income (aka cash flow), and Equity Build. 

Rental real estate investment increases in several ways – primarily through net profit, and through principal payments. The renter pays the owner’s liabilities (interest, insurance, property taxes, and any mortgage insurance), plus net profit. In addition, the renter also pays down loan principal. 

What that means is that the amount of the asset owned increases, plus the owner/investor makes a profit. It's similar to the premise that your stock will rise in value exponentially, AND pay a dividend. Plus, after 30 years (or whenever the loan is satisfied), the investor’s net profit drastically increases when the interest and principal payments end, oddly enough right around time for retirement (if the owner started investment in his/her 20s).

Real estate in North America has traditionally outperformed or similarly compared to the stock market in the medium and long-term. When properties are leveraged (i.e., financing is used to purchase properties) real estate investments have substantially outperformed all major stock indices.
It is clear from the chart below that unleveraged (0% debt) real estate has yielded significantly higher returns for more than 5 years and 50% financed real estate has returned higher yields than the stock market over any period.
The chart below illustrates historical returns of real estate vs. stocks and includes the major North American stock indices as comparisons.
The figure below illustrates the typical growth rate for 50% leveraged properties in North America. However, many real estate investments are financed to a much greater extent: often up to 80%. Using more financing will increase returns well above those shown below.
It is clear that, particularly with the responsible use of financing, investments in real estate significantly outperform investments in stocks over time.

The tax benefit to rental real estate is equivalent for high income investors compared to dividend-paying stocks. Subject to recent (and probably outdated understanding of) changes to dividends, higher income earners may or may not be phased out of lower dividend tax rates.

Some investors prefer real estate because the probability of losing the investment is nil. Houses don't just go bankrupt. You may lose value, have net losses, or suffer a natural disaster, but you typically won't lose the asset.


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