Statistics Canada reports that a mere five percent of Canadians will retire comfortably or wealthy - which segment of retirees will you fall into? When you choose investment real estate as an important component of your balanced portfolio and retirement plan, you are recognizing that real estate investing done right can provide you with a secure, long-term source of income.
A recent Forbes Magazine article stated that 97 out of every 100 self-made millionaires made their fortunes through real estate investing. Believe it or not, you, too, can take control of your financial life by creating wealth through the acquisition of real estate assets.
As a vehicle for creating wealth, financial experts agree it’s hard to beat real estate. Of the four benefits all investors seek (income, tax advantages, appreciation and leverage), no other single investment offers as much as real property.
Principal (Mortgage) Reduction
A mortgage or principal is the amount of money you actually borrow from a financial institution to bridge the gap between your purchase price and your down payment. Your principal borrowed is then paid off over a number of years; 25 years is an amortization commonly used. Having your principal paid down is considered your Principal Reduction. Why is that important? Because underlying all the benefits of Cash Flow, Leverage and Appreciation, there is one fact about real estate that makes it more reliable than any other type of investment, and that is, as long as your mortgage is being paid every month, then every month your equity is increasing. Why? Because the principal amount of your mortgage is slowly being reduced to zero, and when you have no mortgage, you and your family can enjoy positive cash flow and further property appreciation for generations to come.
Property appreciation is yet another way real estate builds wealth. The National Association of Realtors has been tracking home prices since 1968. Home values have increased each year at an average rate of inflation plus one to two percentage points. The longer a property is held, the more likely an investor is to profit from resale, unless the property was purchased at below market value, in which case appreciation would be immediate. But whether instant or gradual, appreciation can create fortunes.
Positive Monthly Cash Flow
While there are a number of investments that may offer this benefit, few can produce as much income relative to the cash invested as real estate. Rental income that exceeds a property’s expenses creates a positive cash flow for the investor. With a fixed-rate mortgage, an investor can insulate a large part of his costs against rising property values. Then, as rents increase so does cash flow.
The tax benefits of real estate are many. Besides mortgage interest, property taxes and a slew of other deductible business expenses, there is depreciation, which in some cases can provide tax losses to offset other personal income.
You can defer taxes owing on the value appreciation of your investment property until you sell, meaning your investment value can grow tax-free year after year, and giving you the benefit of tax-free compound growth.
You also benefit from the "Capital Gain" status of property value appreciation, which means in Canada, according to the CRA legislation, you will be taxed on just 50% of the gain and 50% of your gain is tax free! For further clarification of this, please advise with your accountant.
Have you ever taken out a loan to buy a car? By doing this, you tapped into other people’s money (the bank’s) to buy the car. How much better would it be if you also had someone else making the payments for you? By investing in real estate, you do just that. Instead of using other people’s money to accrue additional expenses, you use other people’s money (the bank’s) to buy the property, and you use other people’s money (your tenants) to make the payment by renting the property out for more than it costs you to own it. The income produced by the property that is left over after all expenses are paid for is the property’s cash flow. And simply put, that is the power of leverage.
How much or how little cash an investor puts up greatly affects the yield in rental properties. If, for example, a property has a positive cash flow of $2,000 a year but the investor had to come up with a $10,000 down payment to make the purchase, the return would be 20 percent per year. Not bad, but if the same cash flow could be maintained with a $5,000 down payment, the return would be 40 percent. Using a no-money-down technique to purchase the property could yield an infinite return.
Leveraging borrowed funds gives a return far in excess of the property’s appreciation rate. An investor may put down 10 percent on a property, but might reap an annual return of 100 percent as a result of the price appreciation. Even a modest 3 percent annual rise in the value of a property bought with 10 percent down generates a 34 percent annual return on invested capital if the property is held at least three years.
The less an investor puts down, the more leverage. Usually the greater the leverage, the higher the mortgage payments, so care must be taken in property selection and contract negotiations to be sure the property will support the payments.
Profit from any market cycle
Real estate can also build wealth in any economic climate. If the real estate market is up, quick turnaround investments (flips) can produce large, immediate gains. If the market is down, there are more opportunities to acquire assets at a lower cost due to foreclosures, motivated sellers and seller financing. When interest rates are low you can buy more assets for your buck. When interest rates are higher, more people are prompted to rent apartments-- which translates into higher rental prices. The increased demand turns your real estate asset into a cash flow cow.
Everybody Needs a Roof Over Their Head
As if these benefits aren’t enough, there’s one other that absolutely no other investment provides, and that’s shelter. Whether for your family or for your tenants, when you invest in residential real estate you are providing someone with a home.
Unlike "paper assets" such as stocks or derivative market instruments, real estate is something real and tangible. It physically exists! Even more importantly than this is the fact that everybody needs a roof over their head, and we all need space and a place to live.
As long as there are people in a given area, there will be demand for real estate.
Unlike virtually every other asset class, real estate is finite. Sure we can always build taller buildings with more apartments in them on the same size block of land, but there is only so much land, and only so much "well located" land near to public amenities, employment, and transportation.
The land component of real estate makes for such an outstanding asset class: because they aren’t making any more of it!