With the stock market entering into correction territory for the second time this year, investors may be looking for alternative ways to invest or diversify their portfolios. Real estate is a time-tested method for building wealth and creating passive income that offers loads of additional benefits, including the opportunity to build equity, leverage assets to build larger portfolios, and even get a tax break or two. For those on the fence, here's a closer look at why investing in real estate is a surefire way to make you richer.
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Passive income
Passive income is one of the most attractive aspects of investing in real estate. Cash flow, after all, is essential for creating financial freedom and can be enormously helpful in supporting a comfortable retirement. If you already invest in the stock market, chances are you're familiar with the benefits of investing in dividend stocks. But what many investors don't realize is that real estate investment trusts (REITs) are among some of the best dividend-paying stocks in the market.
For REITs to benefit from certain tax advantages offered in the REIT structure, the companies are required to follow certain rules, including paying 90% of their taxable income in the form of dividends. That means REIT dividend returns are often much higher than traditional dividend stocks. According to the National Association of Real Estate Investment Trusts (Nareit), the average dividend return for REITs is 2.85% -- over double the average dividend payout from the S&P 500, which is currently 1.36%.
REITs aren't the only way to earn passive income in real estate. Rental real estate, which can include leasing commercial real estate or residential housing like a single-family home, can provide monthly rental income for years. According to ATTOM Data Solutions, in 2021, the average rental return for individual markets ranged between 3.7% and 26.1%. Of course, returns will vary depending on the property's location, purchase price, rental potential, and associated holding costs, but rental real estate can be a reliable form of passive income.
Growth opportunities
Whether you're investing in REITs or own and manage a rental property on your own, the growth potential can be a huge reward for investing. Over the past 20 years, home prices have risen 7%, on average, per year for a whopping 140% total gain in median home price from 2001 to 2021. Meaning a $200,000 rental property purchased in 2001 would be worth $480,000 today. Equity can be a huge reward for owning rental real estate; plus, if purchased properly, the rental income earned should cover any debt costs such as a mortgage. In other words, tenants build equity for you.
Publicly traded REITs, as tracked by Nareit, have outperformed the S&P 500 over the past 20 years, seeing a 6% annualized price increase and 10% annualized return. However, several REITs have far outpaced the norm, with double-digit and even triple-digit growth over the past decade.
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Tax benefits
While not all real estate investments can offer tax benefits to investors, those who own rental real estate can unlock some powerful tax advantages. Depreciation, which is writing off a percentage of a property's value each year to account for average wear and tear, can help reduce the investor's tax basis when it comes time to file your tax return. Certain expenses can also be deducted, offsetting income and, ultimately, lowering how much income is earned in a year on a taxable basis.
Leveraging your assets to grow
Real estate also offers the ability to leverage investment to grow a portfolio. Let's say you own a rental property free and clear, thanks to the last 15 years of rental payments from your tenants. Rather than sell the property to buy another, you can simply leverage the equity built in the first rental to buy another through a home equity line of credit or by refinancing the property.
You can also use a mortgage to leverage how much you have to invest in a property. Down payments for investment properties are a minimum of 20%. With interest rates still sitting near record lows, investors can access a property worth $200,000 for $40,000, paying a fixed low-interest mortgage for up to 30 years.
Savvy investors use leverage to their advantage, buying a property at a discount, renovating it, renting it, and then refinancing it at its new higher value -- an investing method frequently referred to as BRRR (buy, renovate, rent, refinance). With this strategy, you can usually recoup any investment in the property while adding a cash-flowing rental to your portfolio to hold for the long term.
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Hedge inflation
Physical real estate is also great at hedging against rising inflation as real estate values and rental rates adjust in relation to the inflation rate. With today's inflation holding steady at 7.5%, this is massively helpful in ensuring investors keep pace or outperform the inflation rate.
A long-term way to get richer
If you combine these investment options and advantages, you can see how a single investment in real estate could make you significantly richer. With enough time, sufficient due diligence, and careful management, a rental property or an investment in the right REIT can pay off hugely. As with any investment, there are risks and downsides to investing in real estate, one being the lack of liquidity in owning rental real estate. However, the advantages and potential wealth-building power of investing in real estate often outweigh the drawbacks.
