Here at Teachers Stacking 10s, we have talked in depth about saving and investing your money into stocks and index funds. We have spent a lot of time in this area because almost all of us as teachers have a 403(b) account in which we invest. It’s also a very simple method for growing your money, but is it the “best” way to grow your money? If you want to be a passive, hands-off investor, yes, stocks, especially index funds, are going to be your best bet. But as we have seen these last couple of weeks, the stock market can drop precipitously and without warning.
This brings us then to the idea of real estate. As the title of the post states, real estate has created more millionaires over time than any other. So why is real estate such a powerful driver of wealth? To answer this question, we have to look at the four different ways that real estate can grow your wealth faster than most other investments.
Wealth Generator #1 – Cash Flow
This is the area that attracts most people to real estate investing. People hear of someone who is making an extra $300+/per month on this rental property that they purchased. This is the passive income stream that we have talked about in previous posts. Now, like index funds, this cash flow can go up and down. Factors such as capital expenses, vacancy, repairs can significantly impact your monthly cash flow. This is why real estate has a steep learning curve. You have to understand cap ex, taxes, vacancy rates, property management, etc.. All of these things can affect your bottom line. We could compare this to dividends in an index fund except real estate cash on cash returns can easily exceed 10% compared to 2-3% in a dividend fund.
Wealth Generator #2 – Appreciation
Appreciation is when the house you buy goes up in value over time. This is similar to buying an index fund and having it the price increase. The average house in America appreciates on average 3% each year. Of course, this can vary greatly from location to location so it is important to make sure you understand the area that you are purchasing in to guarantee yourself the best chance of appreciation. Unlike stocks, you have the opportunity of “forced appreciation” in real estate by improving your property through repairs or additions. But like stocks, the price of your home could drop in a housing market downturn like we saw in 2008.
Wealth Generator #3 – Mortgage Pay Down
This is where real estate starts to really show its true wealth building ability. Mortgage pay-down is the paying down of the loan that you took out when you purchased the property. Very few people in real estate pay all cash on a property. The most common method or purchasing real estate is to pay 20-25% down and then “leverage” other people’s money for the rest of the property. This is similar to buying stock on “margin”, BUT in real estate, your tenants are the ones paying down that loan. So if you purchased a $100,000 property for $20,000, after 30 years your tenants would pay off that $80,000 loan for you! When you buy stocks on “margin”, or borrowed money, nobody is paying that loan but you!
Wealth Generator #4 – Tax Benefits
This final area is the one that shows how real estate investing is the “favored” method of growing wealth in America. Each year that you own the property, the government allows you to “depreciate” your asset. This means that the government feels that the house is going down in value by a certain amount each year due to wear and tear, and you can deduct that amount from your taxes. You cannot “depreciate” stock. Now, the government of course wants to recapture that depreciation that you have deducted when you go and sell that house, BUT there is something called a 1031 exchange that allows you to sell that property and purchase another, hopefully larger property, WITHOUT paying those taxes. With this 1031 exchange, you are able to delay these taxes forever. This enables an intelligent real estate investor to “trade up” properties every few years to improve their cash flow. So you could realistically start out with a single-family home. A few years later move up to a duplex. Maybe 5 years later exchange up to a four-plex, etc.. Continuing to do this could allow you to to upgrade from that SFH to a 16-unit apartment complex over the course of 20 years!
As with all types of investing, there are risks. Successful real estate investing requires time, effort, and knowledge. You will not be able to jump right in to real estate investing without doing your homework. Fortunately, there are numerous sources out there for you to study. One of my favorites is the Bigger Pockets website. I have used this site for the past couple of years as I build my knowledge in real estate. I have also started attending our local real estate investor meetings. Real estate is huge “relationship” business. You have to be willing to meet people and connect with others in the industry. Through these relationships, I am hoping within the next year to make my first purchase of a rental property. In my next post on real estate, I will discuss the different strategies when entering real estate. In the meantime, everybody….
KEEP STACKIN!