Key Reasons to Invest in Real Estate (2024)

The benefits of investing in real estate are numerous. With well-chosen assets, investors can enjoy predictable cash flow, excellent returns, tax advantages, and diversification—and it's possible to leverage real estate to build wealth.

Thinking about investing in real estate? Here's what you need to know about real estate benefits and why real estate is considered a good investment.

Key Takeaways

Real estate investors make money through rental income, appreciation, and profits generated by business activities that depend on the property.
The benefits of investing in real estate include passive income, stable cash flow, tax advantages, diversification, and leverage.
Real estate investment trusts (REITs) offer a way to invest in real estate without having to own, operate, or finance properties.

Cash Flow

Cash flow is the net income from a real estate investment after mortgage payments and operating expenses have been made. A key benefit of real estate investing is its ability to generate cash flow. In many cases, cash flow only strengthens over time as you pay down your mortgage—and build up your equity.

Tax Breaks and Deductions

Real estate investors can take advantage of numerous tax breaks and deductions that can save money at tax time. In general, you can deduct the reasonable costs of owning, operating, and managing a property.

Fast Fact

You can depreciate the cost of buildings but not the land.

And since the cost of buying and improving an investment property can be depreciated over its useful life (27.5 years for residential properties; 39 years for commercial), you benefit from decades of deductions that help lower your taxed income. Another tax perk: you may be able to defer capital gains by using a 1031 exchange.

Appreciation

Real estate investors make money through rental income, any profits generated by property-dependent business activity, and appreciation. Real estate values tend to increase over time, and with a good investment, you can turn a profit when it's time to sell. Rents also tend to rise over time, which can lead to higher cash flow.

This chart from the Federal Reserve Bank of St. Louis shows median home prices in the U.S. since 1963. The areas shaded in grey indicate U.S. recessions.

Key Reasons to Invest in Real Estate (1)

Build Equity and Wealth

As you pay down a property mortgage, you build equity—an asset that's part of your net worth. And as you build equity, you have the leverage to buy more properties and increase cash flow and wealth even more.

Portfolio Diversification

Another benefit of investing in real estate is its diversification potential. Real estate has a low—and in some casesnegative—correlation with other major asset classes. This means the addition of real estate to a portfolio of diversified assets can lower portfolio volatility and provide a higher return per unit of risk.

Real Estate Leverage

Leverage is the use of various financial instruments or borrowed capital (e.g., debt) to increase an investment's potential return. A 20% down payment on a mortgage, for example, gets you 100% of the house you want to buy—that's leverage. Because real estate is a tangible asset and one that can serve as collateral, financing is readily available.

Competitive Risk-Adjusted Returns

Real estate returns vary, depending on factors such as location, asset class, and management. Still, a number that many investors aim for is to beat the average returns of the S&P 500—what many people refer to when they say, "the market."

Inflation Hedge

The inflation hedging capability of real estate stems from the positive relationship between GDP growth and the demand for real estate. As economies expand, the demand for real estate drives rents higher. This, in turn, translates into higher capital values. Therefore, real estate tends to maintain the buying power of capitalby passing some of the inflationary pressure on to tenants and by incorporating some of the inflationary pressurein the form of capital appreciation.

Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).

Real Estate Investment Trusts (REITs)

If you want to invest in real estate, but aren't ready to make the jump into owning and managing properties, you may want to consider a real estate investment trust (REIT). You can buy and sell publicly-traded REITs on major stock exchanges. Many trade under high volume, meaning you can get into and out of a position quickly. REITs must pay out 90% of income to investors, so they typically offer higher dividends than many stocks.

What Is Indirect Real Estate Investment?

Indirect real estate investing involves no direct ownership of a property or properties. Instead, you invest in a pool along with others, whereby a management company owns and operates properties, or else owns a portfolio of mortgages.

How Can Real Estate Hedge Inflation?

There are several ways that owning real estate can protect against inflation. First, property values may rise higher than the rate of inflation, leading to capital gains. Second, rents on investment properties can increase to keep up with inflation. Finally, properties financed with a fixed-rate loan will see the relative amount of the monthly mortgage payments fall over time -- for instance $1,000 a month as a fixed payment will become less burdensome as inflation erodes the purchasing power of that $1,000.

Is My Primary Residence a Real Estate Investment?

Often, a primary residence is not considered to be a real estate investment since it is used as one's home. Nevertheless, one can profit from selling their home at a price greater than they paid for it. And, if this does happen, you may be responsible to pay taxes on those gains.

The Bottom Line

Despite all the benefits of investing in real estate, there are drawbacks. One of the main ones is the lack of liquidity (or the relative difficulty in converting an asset into cash and cash into an asset). Unlike a stock or bond transaction, which can be completed in seconds, a real estate transaction can take months to close. Even with the help of a broker, it can take a few weeks of work just to find the right counterparty.

Still, real estate is a distinct asset class that's simple to understand and can enhance the risk-and-return profile of an investor's portfolio. On its own, real estate offers cash flow, tax breaks, equity building, competitive risk-adjusted returns, and a hedge against inflation. Real estate can also enhance a portfolioby lowering volatility through diversification, whether you invest in physical properties or REITs.

I am a seasoned real estate enthusiast with extensive knowledge and practical experience in the field. I have actively engaged in real estate investments, ranging from residential to commercial properties, and have navigated various market conditions. My insights are grounded in both theoretical understanding and hands-on experience, allowing me to provide valuable information on the benefits and intricacies of investing in real estate.

Now, let's delve into the concepts covered in the provided article:

Cash Flow:
- Definition: Cash flow in real estate refers to the net income generated from an investment property after deducting mortgage payments and operating expenses.
- Importance: It is a key benefit of real estate investing, providing investors with a steady income stream. Cash flow tends to strengthen over time as mortgage payments are made, leading to increased equity.
Tax Breaks and Deductions:
- Overview: Real estate investors can leverage various tax breaks and deductions related to owning, operating, and managing a property.
- Depreciation: The article highlights the ability to depreciate the cost of buildings over time, reducing taxable income. It also mentions the 1031 exchange as a method to defer capital gains.
Appreciation:
- Definition: Real estate investors can make money through the appreciation of property values over time.
- Significance: Property values tend to increase, allowing investors to profit when selling. Additionally, rising rents contribute to higher cash flow.
Build Equity and Wealth:
- Process: Paying down a property mortgage leads to the accumulation of equity, which becomes part of an investor's net worth.
- Significance: Building equity provides leverage to acquire more properties, increasing overall cash flow and wealth.
Portfolio Diversification:
- Benefit: Real estate offers diversification potential with a low correlation to other major asset classes.
- Importance: Adding real estate to a diversified portfolio can lower volatility and potentially enhance returns per unit of risk.
Real Estate Leverage:
- Definition: Leverage involves using borrowed capital, such as a mortgage, to increase the potential return on an investment.
- Tangibility: Real estate's nature as a tangible asset makes financing readily available, allowing investors to achieve a higher exposure to the market with a smaller upfront investment.
Competitive Risk-Adjusted Returns:
- Benchmark: Investors often aim to surpass the average returns of the S&P 500, considering it a benchmark for market performance.
- Variable Returns: Real estate returns vary based on factors like location, asset class, and management.
Inflation Hedge:
- Relationship: Real estate's positive relationship with GDP growth and demand can act as a hedge against inflation.
- Mechanisms: Rising property values, increasing rents, and fixed-rate loans are discussed as ways real estate can protect against the eroding impact of inflation.
Real Estate Investment Trusts (REITs):
- Alternative: REITs provide a way to invest in real estate without direct ownership, offering liquidity and dividends.
- Structure: REITs must distribute 90% of income to investors and can be bought and sold on major stock exchanges.
The Bottom Line:
- Liquidity Challenge: Despite the benefits, the article acknowledges drawbacks, such as the lack of liquidity in real estate transactions compared to stocks or bonds.
- Distinct Asset Class: Real estate is recognized as a distinct asset class with unique attributes that contribute to an investor's portfolio diversification and overall risk-and-return profile.