There are at least 11 completely unfair advantages of real estate investing over the stock market – ESPECIALLY for real estate agents! Most people are completely unaware of these advantages, so let’s fix that right meow:
Table of Contents
Unfair advantage 1 – Monthly cash flow
Friends often ask me when I’ll pay off my apartments and start making money. They’re always baffled when I say already I make cash every single month! Yes, you can have a positive cash flow on a financed rental property.
Cash. In your pocket. Every month.
Most stock market investors won’t actually realize any profits until they sell the stocks. This carries risk, especially if the market tanks right about the time you want to use the money, like to start your retirement.
Unfair advantage 2 – Free equity: someone else pays the mortgage
I hate paying bills. But I love that my tenants pay for the financing on my apartments. I wish someone else that would pay my home mortgage too!
If this doesn’t seem right, just think about this: rental property is an INVESTMENT. By definition, an investment has to make money. So if you buy rental properties at the right price, you can pay the mortgage and all expenses with the rent and have additional monthly profit.
This is the reason I have no plans to pay off any property. I always want it financed so that I can have that equity invested in MORE property.
Unfair advantage 3: Every expense is tax deductible
I love it when I tell friends that I own apartments. The first response is almost always:
“I don’t want to own property. I don’t want to fix toilets at 3 am.”
This matter-of-fact statement is always followed by an awkward, smarter-than-thou chuckle. My response:
“I don’t fix toilets. I hire someone for that. It’s tax deductible!”
There’s never a come back when people realize that I’m making money after all the expenses are paid.
When I first started real estate investing I did self manage and did little things myself. But after a year I turned everything over to management, which is totally worth the return on time!
Repairs, labor, and management – it’s all tax deductible! Why waste time fixing toilets when you could be looking for more cash flowing property instead?
To fully realize tax benefits as one of the advantages of real estate investing, hire a real estate focused CPA to maximize your financial growth!
Unfair advantage 4 – Deduct the ENTIRE building
So get this: the government lets you depreciate the cost of the building on the property.
Let’s say you buy a $100,000 rental property. The building is worth $80,000 and the land is worth $20,000. The government lets you write off the depreciation of that $80,000, which is usually done over 27.5 years (for residential and multi-family property).
That means that you get to write off the ENTIRE $80,000 price you paid for the building by $2,909 a year for 27.5 years. Uncle Sam pays you back for the building. Lol, what?
There’s a great reason for this. The government doesn’t want to be in the business of real estate. So there are tax deduction advantages of real estate investing so that investors are encouraged to buy, hold, improve, build, and keep all the real estate related business sectors continuously growing.
There’s also something called cost segregation, which allows you to deduct many parts of the property much faster than 27.5 years. This can accelerate growth by reducing tax burden early on.
With depreciation, you can be in a situation where you have a “book loss” on your taxes, even though you could be actually making money!
Unfair advantage 5 – Profit in any market
There are two meanings here: profit in any area of the United States and profit whether the housing market is up or down. Both are doable!
To understand why this is one of the advantages of real estate investing, you have to think creatively. You can find small time investors in Los Angeles, in Washington D.C., Miami, and Denver who are making money on their rental properties. Sure, the cost of entry might be higher, but there are always ways to make money.
If you buy the right kind of rental property, you can be sheltered really well from a housing market downturn. Some example guidelines:
- Avoid
- Luxury properties don’t rent well in recessions
- “War zones” – high turnover and high wear and tear (you can profit, but be willing to WORK)
- Shrinking population centers
- Lots of new construction (cranes in the air, beware!)
- Look for
- Rents under a third of the median income for an area results in reliably paying tenants
- Low vacancy
- Lots of blue-collar and entry-level white-collar jobs
Follow guidelines like this and you’ll be protected well in recessions. Far more protected than if all your investments were in the stock market. Diversify!
Unfair advantage 6 – Trade up tax-free
It’s called a 1031 Exchange by the Internal Revenue Service (IRS). Sell a property. Buy a new one using that money within six months. Pay no taxes on the sale.
Uncle Sam let’s you defer the taxes every time you trade up. Talk about an unfair advantage!
The 1031 provides the opportunity for massive scaling up by not taking a tax hit until you get out of owning property for good. Yes, please.
Unfair advantage 7 – Buy more, pay less: economies of scale
If you buy a single family house, the one rental unit is under one roof.
But if you buy an eight unit apartment building, the eight rental units are under one roof.
If that single family house goes vacant for three months, you lose money for three months.
But if an apartment goes vacant for 3 months, the other apartments pay the bills.
Point made? Plus, you can save costs and negotiate to pay less for trash service, management, shared utilities, mowing, etc. when you have more units in one or nearby locations.
Unfair advantage 8 – Write off travel, meals, fuel, office…
Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes. – Gregory v. Helvering, 69 F.2d 809, 810 (2d Cir. 1934)
As every agent likely knows, real estate is a business, so as far as taxes go:
- Write off travel (gas, hotel, plane tickets, etc.) that is required for the business.
- Need to attend an educational or networking event? Write it off.
- Do you do most of your work from your home office? Write off the space and your computer.
- Is your cell phone your primary real estate tool? You guessed it.
The kind of things you are already writing off as an agent are generally pretty similar when it comes to investing as well. I can’t overstate how important (and honestly difficult to measure) tax benefits are as one of the advantages of real estate investing – you just don’t get that from stocks!
Unfair advantage 9 – “Value add” equates to MASSIVE returns
Value add is where you purchase a property, do some sort of improvements, raise the rents, and that in turn raises the value of the property. This might be my personal favorite of the advantages of real estate investing.
Every time I increase the rent by $10 on my property, the value goes up $1,500. Are you kidding me?
How does this work? Investment property value is based on the net profit it can generate (unlike the single family housing market). So every time you increase the income or decrease the expenses of a property, that increases the profit bottom line.
A way to ballpark the price of a property is using what is called Cap Rate (capitalization rate). For example, in the Midwest right now the cap rates are around 8%. So, a property that nets $10,000 a year would be worth $10,000 / 8% = $125,000.
So every time I bring in $10 more a month on my property, the value goes up ($10/month x 12 months) / 8% = $1,500.
I bought my first 8 apartments with the rents on average about $150 BELOW market value. Let’s say that I slowly increase the rents by that much:
8 apartments x $150 per month rent increase x 12 months / 8% = $180,000
So if all I did was increase the rents to market value, it would increase the value of the property by $180,000.
Of course, this correlation isn’t exact. And to increase the rents this much I have to update units and provide better service to tenants (because that is the right thing). But this effort is ABSOLUTELY worth it. The renovations are tax deductible anyway.
Unfair advantage 10 – Refinance tax free
Guess what? If your property increases in value, like in the add value example in advantage 9, you can pull out the cash equity TAX FREE. Here’s an example.
Let’s say you buy a small set of apartments for $160,000. You put 25% down ($40,000). Then you add value by:
- Making some updates
- Increasing the rents to the local market rate
- Decreasing operating expenses
Now those apartments bring in $1,600 a month after all expenses, repairs, and the mortgage is paid. The new property value in an 8 Cap market would be about: $1,600 x 12 / 8% = $240,000.
You refinance the property at the new value. This looks like:
- +$240,000 new loan (cash!)
- -$60,000 for a 25% down payment
- -$120,000 to pay off the old loan (for easy math)
- +$40,000 in equity on the old loan (the initial down payment)
- =$100,000 cash to pull out of the property
You can pull $100,000 out of your property, tax free. You can use that as a down payment on an even bigger property. Plus, you still own the first cash flowing property.
Unfair advantage 11 – Natural appreciation
When you talk about stock market investing and percentage return on your investment, what is rarely talked about is the impact of inflation. Inflation in the US is generally somewhere between 1.5% to 3% a year. That means that $100 today is only worth $97 to $98.5 in buying power next year.
So if you get a 6% return on an investment, but your money is worth 2% less each year, you aren’t exactly getting a 6% return, are you?
Stock market investments are usually looked at with historical returns in mind, but those returns generally do not have the pain of inflation rolled in.
That’s where appreciation of property comes in. Generally, property appreciates in value in the long run. It isn’t much on average, just a few percent much like inflation. But this creates a long-term counter to inflation! While the buying power of a dollar is going down, the value of the property is going up – a wonderful little yin yang thing going on.
While certainly, property prices can decline and most certainly will in the future at some point (perhaps due to COVID 19…), just like the stock market everything trends upward in the long run. This is why real estate investors should never plan on natural appreciation and only plan on forced appreciation they can control.
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Now go out there and crush some real estate investing!
You can also check out our comprehensive post on Real Estate Investing for Real Estate Agents.