So, you have a little money and you’ve heard the worst thing you can do with it is let it sit in a bank. But what do you do with it? The stock market may come to mind or maybe it’s real estate because everyone always says there’s a lot of money there. But which is the better investment?
You may go to a number of people to ask for their advice, that one uncle that always seems to be on the ball financially, or maybe you even have your own financial advisor. Either way, make sure you take into account who you’re talking to. For example, that financial advisor may receive a commission for selling stocks and managing market funds, meaning their eagerness to get you to invest may not always be in your best interest.
If you’re a numbers person it’s easy to perhaps put this debate in black and white on the surface level of research. Wall Street is usually pretty loud with its numbers, the S&P 500 showing a 10.5% average annual gain in value since 1957. What do you see when you look at real estate? 3.5%. You may stop your research right here and proceed to the game of stocks. However, you’d be doing yourself a disservice by not taking into account the two key advantages of real estate that boost the average return.
#1 Tax Advantages
If you’re too caught up on those return percentages and think that there’s no way real estate produces comparable returns, we’ll bust that perception in a bit but for now, we’ll discuss the tax advantages of real estate investing.
Much like homeowners, if you invest in real estate you can deduct mortgage interest. However, you won’t be able to deduct expenses and depreciation in the same way homeowners are able to.
If you own a short-term rental you can take advantage of several tax deductions, be sure you’re familiar with them going in to save as much dough as possible!
On the other hand, tax advantages don’t exist for stock investing. In fact, when you gain from selling a stock making a profit you’ll owe capital gains taxes.
If you decide to go the route of real estate investing you can also owe capital gains in the case that you sell your real estate investment. However, these taxes can be deferred with a 1031 exchange. Essentially this lets you move your profits into another real estate investment, allowing you to dodge these taxes altogether and forever.
Taxes can be a monster expense to take on. Being smart and knowing the advantages available as a real estate investor can mean serious savings on your tax bills, meaning more ease and less stress come tax season. Profit brought in by the stock market is a lot more likely to be watered down once the necessary taxes are taken out, but profit gained by real estate investing strategies? That’s an investment better protected from government stipulations.
If you have a short-term rental, read about these 7 tax tips that can help you set up your vacation rental business right to avoid and/or be compensated for expenses throughout the year.
#2 Leverage
If you’re unfamiliar with the term, let us explain. Leverage is when you use borrowed capital for an investment, expecting the profits made to be greater than the interest payable. Basically using money that’s not yours to begin with to help boost an investment. Stock investors use leverage for their trades by trading on margin as they call it. Entrepreneurs usually get leverage by taking out business loans.
If you’re dabbling in real estate though, it’s usually in the form of a mortgage loan. Yes, leverage can hold more risk than traditional out-of-pocket investments, and that’s why most everyday stock investors don’t use leverage. Higher risk levels aren’t typically favorable in the stock market.
However, if we’re talking about a mortgage loan, this kind of leverage is considered far less risky than most. Almost every real estate investor leverages assets with a mortgage loan. So don’t think it’s out of the ordinary to take one out, and don’t think there aren’t a ton of resources out there on how to do it right, because so many people do it.
Want to understand and learn more about what counts as leverage? There are several forms in real estate to get to know!
So what does leverage mean for real estate investing? Let’s break it down in an example:
Let’s say you buy a rental house that’s $200,000, and it appreciates at roughly the national average of 3.75%. By next year, it’ll have gained $7,500 in value now standing at $207,500. If it ends up bringing in $500 per month, you’d have an excess of $6,000 a year, for a total gain of $13,500.
With those numbers that’d get you about a 6.75% gain on your investment. If that 10.5% just came to your mind, that’s right that’s still not matching the average produced by the S&P. But, as we’ve just discussed, mortgages can come in to play in your favor. If you mortgaged the house 80%, for the example’s sake say now that you’ve taken on a mortgage you’re not operating at a gain anymore, and instead, you’re breaking even.
Where you once started with the 200,000, you now have paid the downpayment of $40,000 with the mortgage. Remember, it still appreciates through at that same $7,500.
That $7,500 gain is not 6.5% or even 10.5% of the downpayment of $50,000. It’s 18.75%. Adding a mortgage loan can be the ticket to flying way beyond the financial potential the stock market can offer you. And that’s without tax advantages! If you just look at the surface, yeah the stock market appears to be out beating real estate every day of the week. But much like we run our business, we go deeper into the numbers and reality of application to see where the money’s at. In this case, and by taking into account these two big factors (taxes and leverage)-if you can take advantage of these investing in real estate is the way to go to get you the greatest return on your investment. Get educated, know the facts, and keep up to date on trends and new advantages because things are always shifting, and you’ll be on your way to achieving financial freedom!
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