Andy Bales - Directory of Finance & Technology

Real estate has been receiving a lot of attention over the last few years, and that has only increased in this new high interest rate environment. Let’s dive into 3 key reasons why and how it can benefit individuals, regardless of the prevailing interest rates.

KEY INSIGHTS

1. Leveraged Returns

   Real estate offers a remarkable opportunity for leveraging your investment. Imagine acquiring a $1M property with a 10% downpayment for a total investment of $100,000. If you sell in 10 years and see a 4% annual appreciation, your property could be worth $1.48M. If you sell at this point, you would likely clear $400,000, a 4X return on your initial investment!

   Alternatively, consider if you had invested an unlevered $100,000 in the stock market. If it averaged 7% annually over those 10 years. Your investment would be worth $218,000; a solid 2.2X return but roughly half of what real estate would have done. This is the power of leverage and taking advantage of leverage with a hard asset backing the investment can offer solid risk-adjusted returns.

2. Inflation Hedge

   Shielding your wealth against the erosive impact of inflation is a real concern. First let’s think about what causes inflation. At its core, inflation is driven by an increase in the money supply, which leads to higher prices. When more money chases the same amount of goods and services, prices naturally rise. As a result, the purchasing power of each dollar declines, effectively diminishing your real wealth.

   Let’s look at this principle further with an example. Imagine you held $10,000 in a traditional savings account earning .05% interest over a decade, while inflation averages 6% annually. After ten years, your dollars would be equivalent to only about $5,679 in today's terms due to the eroding effects of inflation. Your money would effectively be melting away.

   To safeguard against this phenomenon, you need investments that yield returns outpacing inflation. Real estate, with its historical tendency to appreciate in value at a rate that outpaces inflation, can be an astute choice serving as a tangible and enduring asset.

3. Tax Benefits

   Real estate ownership presents a legitimate way to reduce your tax liability. The government works to incentivize economic activity and rewards those who take some business risk. This is seen in the tax code that can strongly benefit owners of real estate. Real estate unlocks the power of depreciation. By using depreciation, you can deduct a portion of your property's value each year from your taxable income and see significant savings.

   What does that look like in practice? Imagine you own a building that is worth 1M. The tax code allows you to depreciate it over its useful life - let's say 20 years in this example. I.e. each year it is ‘losing’ $50,000 worth of value until year 20 when it is worth $0 (at least on paper). Now, you can take that $50,000 ‘loss’ each year and use it to offset your annual income. So if you were making $100,000 each year, rather than being taxed on the full amount you’d only be taxed on $50,000 and assuming a 25% tax rate a savings of $12,500 each year in taxes. And at the end of the 20 years, you likely have a building that isn’t worth $0, it is likely worth far more than what you paid.