Why Should I Invest in Real Estate?
Real estate can provide much better yields compared to other investments
For most of the 1990s, the Standard & Poor's Index posted earning yields of 5 to 6 percent on average. At the same time, the S&P's dividend yields were only around 2 percent or less. Since dividend-paying stocks tend to be much less volatile, the gains on the appreciation side would not normally be a significant factor. At the same time, bond yields taken as a composite showed only around 5 percent returns. Better yields were riskier, while safer bonds returned lower yields.
The Rise of Real Estate
During the same time period and well into the 21st century, real estate investors have realized attractive returns due to the multiple income streams from real estate investments. Here is a look at some of the reasons why real estate can be beneficial for your investment portfolio:
- Rental yield - This is the percentage yield from direct rental income, it and can be calculated as either gross or net. Experienced investors prefer to calculate the net rental yield which takes the expenses, taxes and other costs into account, and divides by the property value/cost. It could be a negative cash flow, as it doesn't take mortgage payments into account. For this reason, many investors prefer to look at cash-on-cash rental yields. Though the investor can purchase and manage for a yield on this single component that exceeds average stock or bond dividend yields, it is only one of the ways in which real estate returns on investment.
- Appreciation - Rental properties normally appreciate in value with inflation. Increased value can mean sale and reinvestment in higher value properties, or provide an equity line of credit to use for other investments. This is the second, and a historically proven, value component of real estate investment return.
- Inflation-proof investment - Rents usually increase with inflation, while mortgage payments on the property remain stable. This increases cash flow, without the increased expense of holding the property. When inflation goes up, it can also mean more renters as mortgages become more expensive for average consumers. More renters increase demand, so rents can escalate.
- Leverage - Using leverage, while being careful to buy properties with good rental yields, provides greater returns. Using $100,000 in leveraged assets to purchase three properties with down payments, instead of one for $100,000 cash, can greatly increase returns. Of course, all leverage involves risk, so the successful investor must understand how leverage impacts their real estate investments.
- Paying down loans - Amortization, or paying down loans, frees up more investment resources to increase leverage. Some investors use the increased equity in one property to free up funds to invest in others.
- Property improvement for equity - Many investors intentionally purchase properties at a value price, because they lack certain features or could use improvements. They have calculated that the value of the improvements will exceed the cost, resulting in an immediate increase in equity.
While stocks and bonds are inflation-sensitive—and they typically involve only value appreciation potential and low or non-existent dividend/interest returns—real estate provides multi-faceted investment returns.