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Why Should I Invest in Real Estate?
Compared to other investments, real estate can provide much better
yields.
Most of the 1990's, The Standard & Poors Index posted earning yields
of 5% to 6% on average. At the same time, the dividend yields of the S
& P were only around 2% or less. Since dividend paying stocks tend
to be much less volatile, the gains on the appreciation side would not
normally be a significant factor.
At the same time, bond yields taken as a composite, showed only
around 5% returns. Better yields were riskier, while safer bonds
returned lower yields.
During the same time period, real estate investors were realizing
much more attractive returns due to the multiple income streams from
real estate investment:
Rental yield - This is the percentage yield from direct rental income,
and can be calculated as either gross or net. Experienced investors
prefer to calculate the Net Rental Yield (calculation detailed here),
which takes the expenses, taxes and other costs into account, and
divides by the property value/cost. It could be a negative cash flow, as
it doesn't take mortgage payments into account. For this reason, many
investors prefer to look at Cash-on-Cash rental yields. The example at
the link shows a 6.4% example return on cash invested. Though the
investor can purchase and manage for a yield on this single component
that exceeds average stock or bond dividend yields, it is only one of
the ways in which real estate returns on your investment.
Appreciation - Rental properties normally appreciate in value with
inflation. Increased value can mean sale and reinvestment in higher
value properties, or provide an equity line of credit to use for other
investments. This is the second, and a historically proven value
component of real estate investment return.
Inflation is Rent-Friendly - Rents usually increase with inflation,
while mortgage payments on the property remain stable. This increases
cash flow, with more rent income without increased expense for holding
the property. When inflation is up, it can also mean more renters, as
the affordability of homes can be negatively impacted by inflation. More
renters increases demand, so rents can escalate.
Leverage - Using leverage, while being careful to buy properties with
good rental yields, provides greater returns. Using $100,000 to purchase
three properties with down payments, instead of one for $100,000 cash,
can greatly increase returns. Of course, all leverage involves risk, so
the successful investor must understand how leverage impacts their real
estate investments.
Paying down the loan - Amortization, or paying down the loan, frees up
more investment resources to increase leverage. Some investors use
increased equity in one property to free up funds to invest in others.
Property improvement for equity - Many investors intentionally purchase
properties at a value because they lack some feature or could use some
improvements in condition or amenities. They have calculated that the
value of the improvements will exceed the cost, resulting in an
immediate increase in equity. Get more information on ARV, or After
Repair Value.
While stocks and bonds are inflation-sensitive, and they typically
involve only value appreciation potential and low or non-existent
dividend/interest returns, we see here that real estate provides
multi-faceted investment returns.