Home Investing Comparing Real Estate To Other Investments: How Do They Differ?

Comparing Real Estate To Other Investments: How Do They Differ?

by Carter Taylor
Comparing Real Estate To Other Investments

You’ve either considered or heard about a number of different investments over the years. To help you appreciate and understand the specific characteristics of real estate, we compare and contrast the characteristics of real estate with those of other wealth-building investments such as stocks and small businesses.

Returns 

Clearly, the key reason why many people invest in real estate is for healthy overall returns (including continuing cash flow and property appreciation). Real estate also produces robust long-term returns because like stocks and small businesses, it is an investment in ownership. By that, we say that real estate is an asset that is capable of generating periodic earnings and earnings or gains by refinancing or selling.

Our analysis and experience show that overall returns on real estate investment are comparable to the returns on inventories—about 8 to 9 per cent on average per year. Over the last decades, the average annual return on real estate investment trusts (REITs), publicly traded companies investing in income-producing real estate, such as apartment buildings, office complexes and shopping centers, has also risen at this pace.

And you can make long-term returns on average much higher than 10% a year if you pick the right properties in the best places, keep them in place for a few years, and maintain them well.

Risk Assessment

Real estate is not often value-aware of the downturn that occurred in most areas of the U.S. in the late 2000s and early 2010s. That said, real estate market values usually do not suffer from as much uncertainty as equity markets do. You can remember how the optimism surrounding the rapid and sustained rise in technology and internet stock prices at the end of the 1990s transformed into the dismay and anguish of the stock prices of those same industries, which crashed in the early 2000s. Many stocks in this industry, including those of niche leaders, have seen their stock prices plummet by 80 per cent, 90 per cent or more. Generally, you don’t see these kinds of drastic roller coaster swings in valuation over the short term in the home income real estate market.

However, keep in mind (especially if you appear to be concerned about shorter-term risks) that real estate can experience a decline of 10%, 20% or more. If you make a down payment of, say, 20 per cent and try to sell your property after a price drop of 10 to 15 per cent, you will find that all (as in 100 per cent) of your invested dollars (down payment) will be wiped out after you make a transaction cost factor. And you will risk it all.

Liquidity

Liquidity—the ease and expense at which you can sell and get your money out of an investment—is one of the drawbacks of real estate. Real estate is relatively illiquid: you cannot sell a piece of property at the same pace as you can take out your ATM card and withdraw money from your bank account or sell a portfolio or an exchange-traded fund by pressing the mouse on your machine or by tapping your cellphone.

While investment in real estate is generally less liquid than stocks, it is generally more liquid than investment in your own or someone else’s small business. People need a place to live and businesses need a place to work, so there is still demand for real estate (although the availability of such available assets may well outweigh demand in certain areas over a period of time).

Requirements for Capital

While you can easily get started with conventional investments such as stocks and mutual funds with a few hundred or a thousand dollars, the vast majority of quality real estate investments require much greater investment—usually in the order of tens of thousands of dollars.

Worth of Diversification

The benefit of owning investment property is that its value does not always change in accordance with other investments such as stocks or small business investments that you hold. You may remember, for example, the dramatic downturn in the stock market in the early 2000s. In most communities across America, real estate rates were either steady or actually rising for stock prices during this horrid period.

However, real estate values and equity prices, for example, will go down in value together (a testament to the extreme recession and the collapse in the stock market that took place in 2008). Sluggish market conditions and lower corporate profits will depress stock and property prices.

Opportunity To Add Value

While you may not know anything about investing in the stock market, you may have some good ideas about how to develop your property and make it more valuable. You may repair or further grow a property and increase rental income accordingly. You may be able to buy a property below its fair market value through legwork, patience, and strong negotiating skills.

Relative to buying in the stock market, tenacious and steadfast real estate buyers can more easily purchase properties on the private real estate market below fair market value because the real estate market is much less competitive and some owners do not know the value of their property profits or need to sell quickly. Theoretically, you may do the same on the stock market, but the scores of experienced full-time money managers who study the stock market make it more difficult to find bargains.

Be Mindful of the Tax Advantages

Real estate investment provides a range of tax advantages. In this section, we compare and compare investment property tax issues with those of other investments.

Deductible Expenditure (Including Depreciation)

Owning a house has a lot in common with owning a small company of your own. You file for your revenue and expenditures on a tax return every year. (We cover all the investment property tax points in Chapter 18.) For now, we would like to remind you to keep a clear record of your investment property purchase and operating expenses. One cost that you get to subtract from your tax return for rental real estate—amortization—does not directly require investing or spending money. Depreciation is an allowable tax deduction for homes, as the structures wear out over time. Under existing tax regulations, residential real estate is depreciated for 271⁄2 years (commercial buildings are less favoured in the tax code and can be depreciated for 39 years). Residential real estate is depreciated over shorter periods of time because it has historically been a favoured investment in our nation’s tax legislation.

Tax-Free Rollover of Rental Property Gains

When you sell a stock, a mutual fund, or an exchange-traded investment that you keep outside your retirement account, you must pay tax on your income. In the other hand, you can stop paying tax on your gains when you sell a rental property if you roll over your benefit to some kind of investment property.

The guidelines for the proper conduct of one of these 1031 exchanges are nuanced and include third parties. Make sure you find a lawyer and/or tax advisor who is an expert in these transactions to ensure that you follow the technical and strict timing standards so that everything goes smoothly (and legally).

If you don’t roll over your earnings, you can owe substantial taxes because of how the IRS determines your earnings. For example, if you purchase a property for $200,000 and sell it for $550,000, you not only owe tax on the rise in the value of the property, but you also owe tax on the additional amount of the depreciation of the property that you used during your tenure. The amount of depreciation you subtract in your tax return decreases the initial purchase price of $200,000, making the taxable gap far greater. For example, if you deduct $125,000 in depreciation from over years in which you owned the house, you owe tax mostly on disparity between the selling price of $550,000 – $75,000 ($200,000 purchase cost – $125,000 depreciation).

Deferred Taxes on Installment Purchases

Installment sales are a complicated tool that can be used to postpone the tax bill while you’re selling investment property for profit and you’re not purchasing another rental property. With such a transaction, you play the role of a banker and provide the buyer with financing. In addition to always collecting a competitive interest rate from the seller, you just have to pay capital gains tax when you receive, over time, the proceeds from the sale to the principal or amount the purchaser agreed to pay for the land.

Special Tax Credits for Old Buildings And Low Income Housing

If you could invest in and repair low-income housing or even certified historic buildings, you will be eligible to receive special tax credits. Credits reflect a direct reduction in your tax bill from the expense of rehabilitating and upgrading those assets. These tax credits exist to allow developers to invest in and restore old or run-down buildings that would likely continue to deteriorate otherwise. The IRS has stringent guidelines governing what kinds of properties can qualify.

The 2017 Tax Cuts and Jobs Act created ‘skilled opportunity zones’ to provide tax incentives to invest in ‘low-income communities,’ which are established by the governor of each state and can comprise up to 25% of designated ‘low-income communities’ in each state. (States can also identify “low-income communities” contiguous census tracts as long as the median family income in those areas does not exceed 125 per cent of the eligible contiguous “low-income community”).
The latest eligible opportunity zone tax incentive offers real estate developers the following possible benefits:

  • The capital gains tax due on the selling of the property is withheld if the capital gain from the sale is reinvested in an eligible opportunity fund within 180 days.
  • Investments in an eligible opportunity fund of at least five years will be subject to a tax increase of 10% of the initial gain by investors.
  • Investors can earn an extra five per cent boost in tax base for contributions in an eligible opportunity fund of at least seven years.
  • Investors can exclude all capital gains from the investment for investments of ten or more years or earlier than 31 December 2026.

20% Eligible Business Income (QBI) Deduction for “Pass-Through Entities”

The 2017 Tax Cuts and Jobs Act contains lower federal income tax rates across the board, which favor both wage earners and investors, including real estate investors. If you spend at least 250 hours a year on certain activities defined at a time related to your investment in real estate, you might also be able to make use of an additional tax break aimed at certain small business entities.

In redesigning the tax code, Congress recognized that many small companies functioning as ‘pass-throughs’ would be subject to higher federal income tax rates relative to the 21 per cent corporate income tax rate (reduced from 35 per cent). Pass-through companies are small businesses, such as sole proprietorships, LLCs, partnerships, and S corporations, and are named because the profits of the company are passed on to the owners and their personal income tax returns.

To fix the issue that individual business owners who conducted their business as a pass-through organization could end up paying a higher tax rate than the 21 per cent rate imposed on C companies, Congress offered 20 per cent of the Eligible Business Income (QBI) deduction for those businesses. So for example, if your sole proprietorship paid you $60,000 in 2019 as a single taxpayer, it would drive you into the 22 per cent federal income tax bracket. But you can subtract 20 per cent of the $60,000 in income (or $12,000) so that you only owe federal income tax on the remaining $48,000 ($60,000 – $12,000).

Another way to look at this is that the corporation will only pay taxes on 80 per cent of its earnings and be in the 22 per cent federal income tax band. This deduction essentially lowers the 22% tax rate to 17.6%.

This 20% pass-through QBI deduction is phased out for service sector owners (e.g. attorneys, physicians, real estate agents, consultants, etc.) with a single taxpayer income of more than $157,500 (up to $207,500) and for married couples with joint income of more than $315,000 (up to $415,000). For other forms of businesses above these income limits, this exclusion may be reduced, so please consult your tax advisor.

The Internal Revenue Service has explained that such rental real estate investor organizations are eligible for a 20 per cent QBI deduction in the tax year in question if the following conditions are met:

  • Separate books and records shall be kept to represent the profits and expenditures of each real estate rental company.
  • For tax years 2022 and earlier, 250 or more hours of rental services are performed (as defined in this revenue procedure) per year in respect of the rental business. For tax 2023 and beyond in any 3 of the 5 consecutive taxable years which end with a taxable year (or in each year for a company retained for less than 5 years), 250 or even more hours of rental services are performed per year in respect of a rental property undertaking.
  • Contemporary records, including timesheets, logs, or similar papers, shall be maintained by the taxpayer as follows:
    • Hours of all services performed;
    • Summary of all services performed;
    • The dates from which such services have been performed
    • The individual who performed the services

Such documents shall be made available for review at the request of the IRS. The provision for contemporary records shall not extend to taxable years previous to 2019.

For the Internal Revenue Service, the leasing service requires the following:

  • Advertising to rent or lease real estate.
  • Negotiation and execution of leases
  • Verification of details found in prospective tenant applications; collection of rents;
  • Operation, care and restoration of property on a regular basis
  • Immobility control
  • Supervision of personnel and independent contractors
  • Purchase of materials

Rental services can be performed by staff or owners, agents, or independent contractors working for the owners. Term rental services do not include financial or investment management operations, such as the coordination of financing; the purchase of property; the study and analysis of financial statements or operating reports; the planning, management or construction of long-term capital improvements; or the time spent commuting to and from real estate.

Real estate used by the taxpayer as a home for any part of the year is not liable for this tax relief. Real estate rented or rented under a triple net lease is also not liable for the QBI deduction.

Final Thoughts

It is necessary for investors to pursue multiple investment opportunities in order to have a high-performance portfolio. There are a range of investments worth considering, from mutual funds to REITs. Whenever making any decisions, investors should consider the advantages and disadvantages of real estate vs. other investments. As a whole, investors can see that real estate is an opportunity to produce an annual cash flow alongside benefits from appreciation over time.

Related Posts

Leave a Comment

* By using this form you agree with the storage and handling of your data by this website.

1xbetbetyapbetebetyatırımsız deneme bonusucasino siteleritipobet

This website uses cookies to improve your experience. We'll assume you're ok with this, but you can opt-out if you wish. Accept Read More

youwinimajbetmilanobetinterbahistipobet