Local Real Estate: Who Invests?

Real estate is a popular investment choice, with 63% of Americans owning real estate according to the Census Bureau. This figure is even higher for millionaires, with an estimated 90% of millionaires investing in some form of real estate.

There are several reasons why real estate is an attractive investment option. Firstly, it provides passive income and tax benefits. Additionally, real estate tends to appreciate over time, and investors can benefit from positive cash flow. It is also a tangible asset, offering a sense of security to investors.

When it comes to demographics, the majority of real estate investors in the US are male (68%) and White (63.8%). The average age of real estate investors is 40 or older, and they typically have a bachelor's degree.

Passive Income

There are many ways to make passive income from real estate. Here are some of the most common strategies:

• Rental Properties: One of the most popular ways to generate passive income is through rental properties. Investors can create a steady revenue stream by collecting rent from tenants. This strategy requires some level of involvement, such as screening tenants, maintaining the property, and addressing repairs.
• Real Estate Investment Trusts (REITs): REITs are companies that own and operate income-producing real estate. They allow individuals to invest in real estate without the hassle of managing properties. REITs are traded on stock exchanges and offer high dividend yields, making them a great source of passive income.
• House Hacking: This strategy involves buying a multi-unit property and living in one unit while renting out the others. House hacking provides rental income that can offset living expenses or generate pure profit.
• Short-Term Vacation Rentals: With the rise of platforms like Airbnb, short-term vacation rentals have become a popular way to generate passive income. Investors buy properties in desirable locations and rent them out to leisure travellers, often commanding higher rental rates than long-term tenants.
• Real Estate Syndications: Syndications allow investors to become limited partners in commercial real estate projects, such as multifamily properties or office buildings. This strategy provides passive income without the day-to-day management responsibilities.
• Debt Investments: Real estate-backed debt is another way to generate passive income. This includes buying mortgage notes, providing hard money loans for house flips or development projects, and investing in mezzanine debt.
• Ground Leases: With ground leases, you generate passive income by owning the land underneath a building and leasing it to the owner of the structure. Ground leases offer predictable income with lower risk compared to other real estate investments.

While these strategies can be lucrative, it's important to remember that passive income in real estate is not completely passive. It often requires upfront investment, ongoing management, and careful planning to be successful.

Additionally, when considering investing in real estate, it's worth noting that, according to the Census Bureau, about 63% of Americans own real estate, and 70% of rental properties are owned by individual investors.

Tax Benefits

Investing in real estate can bring a host of benefits at tax time. Here are six paragraphs detailing the tax advantages of investing in real estate:

Depreciation

Depreciation is the gradual loss of a property's value over time due to wear and tear. As a real estate investor, you can deduct depreciation as an expense on your taxes. That means you'll lower your taxable income and possibly reduce your tax liability. You're allowed to take the depreciation deduction for the entire expected life of a property (currently set by the IRS as 27.5 years for residential properties and 39 years for commercial properties).

Tax Write-Offs

You can deduct expenses directly tied to the operation, management, and maintenance of the property, such as property management fees and the cost to maintain and repair the building. You can also write off much of what you pay to run your real estate investment business, including business equipment (e.g., computer, stationery, business cards, etc.), legal and accounting fees, and advertising and marketing expenses. All of these deductions lessen your taxable income, which could save you money when you pay taxes.

Capital Gains

A capital gains tax may be assessed when you sell an asset, like a piece of property, for a profit. There are two types: short-term and long-term. They each impact your tax situation differently. Short-term capital gains are profits you've made on assets you've had in your portfolio for 12 months or less. These capital gains can have a negative impact on your taxes because they're treated as general income and taxed at your marginal tax rate. Long-term capital gains, on the other hand, are profits from assets you've held for more than one year. Long-term capital gains are generally taxed at a lower rate than short-term gains and don't count as normal income.

Pass-Through Deduction

A pass-through deduction allows you to deduct up to 20% of your qualified business income (QBI) on your personal taxes. When you own rental property as a sole proprietor, via a partnership, or through an LLC or S Corp (known as pass-through entities), the money you collect in rent is considered QBI by real estate tax law. For example, if you have an LLC that owns an apartment complex, you could receive $30,000 in rental income every year. By using a pass-through deduction, you can write off up to $6,000 on your personal return.

Self-Employment FICA Tax

When you're self-employed, you generally need to pay both the employer and employee portion of the FICA tax (covering Social Security and Medicare). However, if you own rental property, the money you receive isn't classified as earned income, so you're exempt from the FICA tax.

Tax-Free or Tax-Deferred Retirement Accounts

Select tax-free and tax-deferred retirement accounts, such as some 401(k) plans and Roth IRAs, may provide opportunities for you to invest in alternative assets beyond stocks and bonds, including private or commercial real estate, real estate investment trusts (REITs), and other property-based holdings. However, tax-deferred and tax-free retirement accounts often come with savings contribution limits, and requirements can vary by account. Before applying, you'll want to consult a qualified financial professional to determine if these accounts can help you lower your tax burden.

Leverage

For example, if you put down a 20% down payment on a $100,000 property, you will only need to invest $20,000 of your own money. The remaining $80,000 can be financed through a mortgage. This allows you to benefit from the appreciation and cash flow of the full $100,000 property while only having invested a fraction of the total cost.

Another form of leverage in real estate investing is the use of other people's money. You can partner with other investors to pool your resources and make larger investments. You can also hire a property management company to handle the day-to-day tasks of managing your rental properties. This allows you to be more passive in your real estate investments while still benefiting from the income and appreciation.

Real estate is also a leveraged investment because it is a tangible asset that can be used as collateral for loans. This makes it easier to access financing for real estate investments compared to other types of investments.

Appreciation

Real estate tends to appreciate over time, especially if you purchase property in an up-and-coming area or make improvements that increase its value. By investing in real estate, you can build equity that will grow in value. This makes real estate a powerful tool for building wealth and achieving long-term financial goals.

Factors Affecting Appreciation

There are several factors that can influence the appreciation of a property. One key factor is the location of the property. Buying real estate in an area with strong economic growth prospects, favourable demographics, and a healthy job market can lead to higher appreciation rates. Additionally, investing in up-and-coming neighbourhoods or areas with planned development projects can also result in significant appreciation over time.

The Impact of Market Conditions

Market conditions also play a crucial role in property appreciation. During periods of high demand and limited supply, property values tend to increase. Keeping an eye on market trends and staying informed about factors that can influence real estate values, such as interest rates and the overall economic climate, is essential for making informed investment decisions.

The Role of Property Improvements

Making improvements to a property can significantly impact its appreciation. Renovations, remodelling, and adding desirable features can all enhance a property's value. Whether it's a residential or commercial property, strategic upgrades can lead to higher appreciation rates and, ultimately, a more profitable investment.

The Benefits of Long-Term Investment

Comparing Appreciation in Real Estate and Other Investments

When comparing real estate to other investments, such as stocks or bonds, it's important to recognise that appreciation rates and patterns can differ significantly. Real estate generally provides more stable and predictable appreciation, especially when compared to volatile markets like stocks. Additionally, the tangible nature of real estate can offer a sense of security, as you can physically see and touch your investment.

In conclusion, appreciation is a fundamental aspect of real estate investment, and it plays a crucial role in the wealth-building strategies of many millionaires. By understanding the factors that influence appreciation and adopting a long-term perspective, investors can leverage the power of appreciation to build their net worth and achieve their financial goals.

Cash Flow

Net Operating Income

Net Operating Income is the income produced by a property on an operating basis. It is calculated by subtracting operating expenses from gross income. Operating expenses include things like property management fees, maintenance and repairs, business licenses, and legal and professional fees.

Positive and Negative Cash Flow

Positive cash flow is when a property's income exceeds its expenses. This is preferable for investors as it means they are making money on the property. Negative cash flow is when expenses exceed income, meaning the investor is losing money.

Calculating Cash Flow

To calculate cash flow, you need to know the gross income the property generates, its total expenses, and any debts associated with the property. Gross income includes rental income as well as any additional fees charged to tenants. Total expenses include property management fees, maintenance and repairs, business licenses, legal and professional fees, and the property's vacancy rate.

Once you have calculated the NOI by subtracting expenses from income, you can then subtract debt service from the NOI to find the net cash flow.

Increasing Cash Flow

There are several ways to increase the cash flow of a property, including:

• Increasing income by raising rents or adding additional income streams, such as fees for pets or parking
• Decreasing expenses by reducing operating costs or appealing property taxes
• Purchasing property at a low price to increase the return on investment
• Investing in property upgrades to make the property more desirable to residents and justify rent increases

Frequently asked questions