More people have made fortunes through real estate than through any other investment medium.
With so many investment mediums why has real estate been one of the most effective ways to generate healthy returns?
1. Leverage
 Have you ever tried to get a loan to invest in the stock market? Or currencies? It is possible but extremely difficult.
In comparison, real estate is an investment class where banks will readily lend money to investors. This in itself is a strong vote of confidence that real estate is a more stable investment than most. Bankers are typically extremely conservative about how they lend out the bank’s money.
This allows the investor to leverage a small amount of capital into a much larger investment.
In an appreciating market this is a great way to increase returns, however, as the last downturn made too evident, it can also work the other way.
Many investors found their leverage worked against them, wiping out the entire deposit in a short period and moving the actual value under the mortgage amount.
Inflation is actually an advantage with leveraged debt on property as the mortgage becomes ‘cheaper’ with time. Case in point is to ask how large a 50,000 GBP debt would have been viewed in the 1960′s compared to if that size of a debt would be considered large today.
So clearly leverage is a valuable tool but, like most tools, needs to be used correctly to prevent injury or damage.
2. Positive cash flow
Real estate is a multi-dimensional investment and one aspect is the cash flow.
In properties either with a high rental yield or low loan-to-value ratios, it is possible to have positive cash flow each month.
Some investors will only purchase properties which have positive cash flow and use a measurement of cash-on-cash return to evaluate a property.
3. Appreciation
Property has one of the most stable and consistent appreciation histories of any asset class.
Equities have historically also performed well with an average of 9.9% compound annual growth rate (S&P 500 Index) if you measured from 1926 to 2010. However, the difference with equities is that the growth can be very sporadic with long-term down periods and other times of very high growth.
By comparison here is a chart of the median home value in the US since 1940 (click for source)
With equities if an investor doesn’t have patience or makes emotional decisions, the timing can really work against them. In contrast, the non-liquid state of a property can force the investor to view things in a longer term way.
Median Home Value in the US
| 1940 |
1950 |
1960 |
1970 |
1980 |
1990 |
2000 |
| $2,938 |
$7,354 |
$11,900 |
$17,000 |
$47,200 |
$79,100 |
$119,600 |
Although the compound annual growth rate from 1940 until 2000 is 6.37%, substantially lower than equities, this does not include the effects of leverage, which would put it much above equities.
The difference with property over equities is that the volatility from year to year has historically been more stable. Using leverage it is possible to achieve higher returns than equities.
4. Principal Reduction
In a tenanted property, the renter is paying down the leveraged amount of mortgage on a continuous basis. You can sell the asset at any time and recoup on the amount of principal that you have paid down.
5. Depreciation
There are few other asset classes where you can depreciate the value of an object and use this to reduce taxes in the short-term, when in actual fact, the asset is growing in value.
In fact, you can have considerable income from a property and not have to pay tax on it because depreciation makes it seem that there is actually not a positive net cash flow.
6. Tax Advantages
Have you ever been able to write off vehicle expenses or hotel costs for an equity investment?
The fact that you can expense many additional costs related to property is a tax advantage which lowers considerably the amount of tax you actually pay on your income.
Do you have any advantages to add to the list above?
After looking at the above advantages, is there any excuse you can make for not putting some of your investment money into real estate? We would be happy to advise you on the best real estate investments currently available in the Czech Republic.
Of course, there are also disadvantages to a real estate investment, including lack of liquidity, high transaction costs, management requirements, etc. This will be the discussion of a future article.
Nathan Brown www.czechpoint101.com
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