When you read that home values have plummeted 30 to 40 percent in some parts of the country, you might wonder why anyone would still be considering investing in real estate. But short-term returns and long-term returns are two different animals. If you are looking for a stable, tried-and-true investment for the long term, consider real estate.
According to the U.S. Census, the median home price in 1940 was $30,000. In 1960 it was just under $60,000. In 1980 it was $93,000. In 2000 it was $120,000. National home sales statistics from January of 2010 show the median price to be $164,000. While data from intervening years show median prices going up in some years and down in others, the long-term trend is clear: Real estate appreciates.
If you spend $100,000 on a bar of gold, you buy $100,000 worth of gold. If you spend $100,000 on real estate, chances are good you are actually buying about $500,000 worth of real estate. This is what is meant by leverage: You invest one amount for an asset worth many times the amount of your investment. Appreciation is based on the value of the asset, not on your investment.
If you buy smart, your rental property will throw off a positive cash flow from day one. “Positive cash flow” means that after you pay all the bills associated with the rental property, you make a profit. Ideally, you will have relatively fixed costs while rents go up every year. Rental income is sometimes referred to as one of the “cash streams”--cash that keeps on flowing with minimal daily labor. When you’re a landlord, you are charging rent 24 hours a day, 365 days a year.
Tax advantages of real estate investing include depreciation, capital gains rate and deferred exchanges. Depreciation is a business expense associated with capital improvements--that is, improvements that add to the value of an asset--and with buildings themselves. To calculate depreciation, take the cost of the asset or improvement and divide it by its “useful life”--this is an approximation determined by the IRS of how long the asset will be in use before becoming obsolescent. The resulting quotient is the amount of depreciation that can be used to offset income each year of the useful life. Capital gains are the profit you make when selling an asset like a rental property. They are taxed at a maximum rate of 15 percent, which is typically lower than the rate that would be charged on the same amount of money had it been earned as employment income. A deferred exchange is a process by which the profits from the sale of a property are reinvested in a new building without having to pay any taxes. Under the right set of circumstances you could use depreciation to show a yearly paper loss on an actual cash gain during your years of building ownership and then sell using a 1031 exchange, avoiding taxes on the profit.
- Victorian Houses - Alamo Square San Francisco image by sebastian kiock from Fotolia.com