Updated: Jul 22, 2022
A plethora of investments exist
Often when people think about investing and the various mediums available, stocks and bonds come to mind. However, the world of investable assets spans beyond these two standard classes and includes options, commodities, and alternative investments, to name a few.
Of these various investments available, one is likely the most ubiquitous of them all: real estate.
Real estate is one of humanity's oldest investment vehicles and is an asset class everyone uses daily. From where you live to where you work to where you shop and dine, someone owns each parcel of land and derives value from it.
Each piece of real estate is different, and what qualities it holds as an investment varies. So, today, we will focus on what qualities real estate can have as an investment, which will be the first part of many in a series to come on this all-spanning asset class.
Qualities as an investment - Appreciation
The first trait real estate holds as an investment is its ability to appreciate, which many homeowners have experienced first-hand!
Often described as an inflation hedge, real estate over the long term (i.e., over decades and centuries) generally increases in value since there is a finite quantity of it. And, due to its scarcity in popular areas, such as in city centers and desirable neighborhoods, it can rapidly increase in price.
Still, that doesn't mean real estate is guaranteed to increase in value. Some places have experienced real estate value collapses in various property-type sectors when the economic tides shift, or natural/human-caused disasters occur. Examples include Detriot after the Great Recession and areas that have become flood-prone due to Climate Change.
Resultantly, buying real estate as an investment solely for price appreciation requires due diligence to ensure that the property selected holds desirable traits.
Qualities as an investment - Income
The second reason real estate can be a desirable investment is its ability to generate income when put to productive use. Examples of such services include providing residential dwellings for families and commercial locations for retailers/businesses.
Notably, this category is broad and includes:
Generating income by renting out dwellings short-term on Airbnb
Providing traditional longer-term residential rentals
Renting raw land for heavy industry
Providing storefront real estate
Renting out warehouse space
People may like the income aspect of real estate because (generally) they can take out a loan to buy a property and then rent it out at a higher cost, allowing them to arbitrage the difference for a profit. However, leverage carries risks, so be careful considering this route.
Qualities as an investment - Royalties
Third, real estate can be a desirable investment due to the royalties that the land can generate when sublet to harvest natural resources. However, this is less common.
Examples of such royalties can include tree farming for lumber, mineral extraction (i.e., gold, copper, silica), aquifer/water use, and more. Some of these extraction activities are renewable, such as farming for lumber, while others are depletable, such as mineral mining.
When subletting land for resource extraction, land owners receive a portion of the extractor's income when the resource sells.
Qualities as an investment - Tax benefits
Finally, any conversation about an investment would be remiss for not mentioning the tax benefits of the asset class.
With real estate, the US Government provides many notable tax benefits, which include: Lower tax rates for passive/rental income
Deductions and depreciation against income
Tax exclusions for individuals and married couples when they make a profit selling a primary residence
1031-Exchanges (an exciting opportunity we will write on in the future)
Real estate can be an excellent investment that can generate value for owners in various ways. While a landowner may buy a parcel of land for one reason, such as rental income, they always have the potential to profit later on from appreciation or royalty payments, as non of these options are mutually exclusive. Furthermore, real estate offers many unique tax benefits that no other investment provides.
However, while real estate has great potential as an asset, it has some drawbacks, which include:
Liquidity issues (it isn't as easy to sell land as a stock)
Purchasing increments can be substantial (buying an entire property costs much more than a single stock or bond)
Lack of diversity/higher risk (unlike ETFs, real estate is an asset that is not diversifiable when buying individual units)
So, while real estate has many benefits, it has drawbacks. And, just like every investment, you must weigh the benefits and risks to decide whether or not real estate fits nicely into your portfolio.
At Lundeen Abrams Advisors, we specialize in Wealth Management and Estate Planning. We understand the role real estate can play in your portfolio and how to utilize it for your benefit and that of your heirs.
If you are interested in discussing investment and tax-planning strategies for properties you own or plan to down the road, be sure to book an appointment with us today.