7 Reasons Why Wealthy People Love Investing in Real Estate
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Andrew Carnegie, the prototypical wealthy industrialist, purportedly said: “Ninety percent of all millionaires become so through owning real estate. More money has been made in real estate than in all industrial investments combined. The wise young man or wage earner of today invests his money in real estate.”
Regardless of the provenance of this quote, it’s hard to deny that investment in real estate is concentrated among the wealthy.
A U.S. Census Bureau study of household wealth released last year showed that in 2013, households with a net worth exceeding $500,000 had median equity of $580,000 in real estate equity. This combined median real estate equity is more than double the total real estate equity owned by households with a lower net worth of 250-500k.
No other combined category — not business ownership, not stocks, not money stuffed under mattresses — came close to matching the amount of equity high-net-worth households have socked away in real estate.
Why do wealthy folks love real estate? There are many reasons, but we’ll highlight seven of the most important ones today. These seven reasons go a long way towards explaining why the wealthy are drawn to real estate as a store of wealth and a builder of long-term fortune.
1. Real Estate Has a Proven Track Record
There are plenty of ways to invest, but out of all of them, real estate may offer the greatest upside. The most expansive study on historical investment returns, The Rate of Return on Everything, 1870-2015, looked at stocks, housing, bonds, and cash in 16 developed economies in data sets spanning more than a century.
What it found was that:
“residential real estate, not equity, has been the best long-run investment over the course of modern history.”
Take a second to consider that — residential real estate is statistically best investment in modern history.
Over the long run, housing provided higher rates of return than the other three asset classes. GDP-weighted real housing returns were 7.76% per year, ahead of the 7.11% real weighted returns for stocks. More importantly, housing provided better returns per unit of risk in all 16 countries. Many countries’ housing stocks produced a half percentage point or more in return per unit of risk than did their equity markets.
It’s worth noting that this only applies to housing, and not to other types of real estate like commercial property or agricultural land.
In many cases, investing in non-residential real estate can produce better returns than simply buying a house and renting it out — provided you’ve done your research on the location and its economics.
It’s also worth noting that, unlike individual equities, it’s generally unlikely that real estate that’s maintained and regularly occupied will ever go to zero or otherwise become worthless.
The upside in real estate comes largely without the degree of randomness involved in equity investing. There’s a reason why stories have circulated for years about a monkey who beat the market by throwing darts at The Wall Street Journal’s ticker page, and why there are no similar stories of primates becoming successful real estate investors.
Real estate investing rewards dedication and adherence to process. Equity investing could reward you for your due diligence, but it could just as easily poke you in the eye with some horrible secret that blows up your entire investing thesis.
2. Real Estate is Stable
Real estate investors tend to have a diametrically opposite risk profile to day traders. Where the latter banks on volatility to make their money, most real estate investors pursue property because it’s viewed as a stable asset with a performance that’s only weakly correlated to stock market moves.
The National Council of Real Estate Investment Fiduciaries (NCREIF) published a study last year that showed:
Real estate’s return volatility averaged just 0.67% from 1987 through 2017, which is far lower than the stock market’s average annualized daily return volatility of 16% from 1966 through 2015, or its average annualized monthly return volatility of 14.9% over the same period.
Even when considering the boom-and-bust period of the last decade, the appreciation of real estate conforms to a fairly stable upward trendline of 3.3% per year since 1977, as measured by the NCREIF’s Market Value Index.
This index doesn’t even track the growth of real estate that undergoes significant renovations or improvements, which can have a significant positive impact on value if undertaken in a cost-conscious way.
3. Real Estate Investing Allows You to Leverage Your Money
Using other people’s money is a proven path to success in multiple investing disciplines. However, the difference between leveraging your investment with loans as an equity investor, and doing so as a real estate investor, is that the former offers a much riskier downside.
If you buy stocks on margin and the market crashes to the point where your shares are worth nothing, you’re still on the hook for the borrowed amount, and you’ve done nothing to build credit along the way.
Taking out a loan or mortgage, on the other hand, will not only build your personal and/or business credit while you build equity in the property, it’s also more protected on the downside because real estate almost never goes to true zero. Floods and fires are typically covered by property insurance, and even in a real estate downturn, most properties can be rented out to cover the monthly mortgage costs while you wait for recovery.
Becoming a fix-and-flip type of real estate investor will also open up access to alternative forms of lending, particularly once you’ve proven your mettle.
In the stock market, accessing the greatest amount of capital from alternative sources tends to require becoming an investment manager or necessitate opening a hedge fund or other investment firm. This is an avenue open to far fewer people than the hard-money loans available for battle-tested real estate investors.
4. Real Estate Gets You Tons of Tax Breaks
Unless you’re a hedge fund manager, the tax breaks available to you for equity investing are somewhat limited. Many of them also happen to require reporting investment losses or socking money away into retirement accounts that impose stiff penalties for early withdrawals. There are tax benefits to equity investing, but they can be pretty restrictive, and most aren’t available to Joe 401(k).
On the other hand, real estate investing offers many tax breaks to every level of investor. There are too many to list here, but a little research will reveal dozens of possibilities. For example, here are ten real estate tax benefits compiled by the Mad Fientist:
- Rental Income
- Capital Gains
- Live-In Flips
- Tax-Free Exchange
- Installment Sales
- Tax-Free Borrowing
- Self-Directed IRAs
A different list from Morris Invest also has ten tax breaks for real estate investing, but many of them are different from the Mad Fientist list. For example, you can deduct loan interest, repair costs, travel for the business of managing your property, employee wages, insurance, and professional services. Treating real estate investing like a business opens up a whole range of tax breaks beyond those tied to the property itself.
5. Real Estate Has Advantages During a Recession
Real estate didn’t escape the 2008 recession, but real estate investors who managed their assets well and avoided over-leveraging themselves came out of the crash just fine.
The value of real estate across the country has largely surpassed pre-recession highs — but unlike stocks, many real estate investors continued to derive usefulness and income from their investment properties during the bust.
Of course, it’s important to understand that there are no truly “crash-proof” investments. Diversification is essential, no matter the investment class. But real estate has some subtle advantages in a crisis.
When the economy tanks, dividends are cut or suspended and illiquidity in the stock market makes it more difficult to divest without taking a bath on your investments. Real estate, on the other hand, can still be used as housing, storefronts, farmland, or one of the many other forms of income-generating property an enterprising investor might acquire.
There were many “real estate investors” who lost their shirts during the recession. The bulk of these investors were relative neophytes drawn in by fast-talking seminar hucksters, their buying binges fueled by mortgage loans that had such minimal oversight that they were regularly extended to people who couldn’t read the documents or prove that they had the income to make their payments.
Experienced and clear-headed real estate investors fared better than these newbies by focusing on owning rental properties in high-demand areas, instead of chasing a quick-fix-and-flip dream of easy wealth that helped destabilize the economy.
Nothing is crash-proof, but people will always need a place to live and to work. Owning rental property is a proven way to mitigate the damage of an economic downturn.
6. Real Estate Fits Multiple Investment Styles
- Buy and hold a property for 30 years to build a nest egg with real estate equity? That’s a time-tested method used by millions of real estate investors who prefer to focus on a career or business while their money works for them in the background.
- Would you rather ensure a steady income stream for years to come? Investing in triple-net properties can lock in a lessee for decades.
- Would you rather put in some work and turn real estate investing into a profitable career? You certainly can. There’s an entire industry devoted to teaching people how to be “active” real estate investors doing multiple profitable deals every year.
Investing isn’t one-size-fits-all, but there are multiple approaches to, and techniques for, real estate investing. You can even be something akin to a day trader with the fix-and-flip style of investing, which is less popular today than it was a decade ago now that most people understand the real risks behind leveraging yourself up to rehab a property with an ideal holding period of just a few weeks. This active style of real estate investing leads to our next point…
7. Real Estate Rewards Hard Work
When it comes down to it, investing in the stock market often has as much to do with luck as it does with analytical skill. Someone who parks their money in an index fund and leaves it alone for 40 years may very well wind up ahead of someone who spends hours every day analyzing SEC filings and insider business news.
Your stock returns can also be substantially impacted if you buy the day before a big pop, or just prior to a damaging report that scares away a big chunk of Wall Street money.
On the other hand, real estate investing favors hard work, detailed research, and savvy operational skills. This is particularly true for active real estate investors, who scour local markets for bargains and beaten-down properties that can be profitably rehabbed.
Fix-and-flip real estate investing can and often does become a career and a business in its own right. It requires skillful money management, excellent partnership and negotiation skills, a mind for marketing, and an ability to handle diverse stakeholders.
This means everyone from the contractor who fixes up the plumbing to the accountant who uses every trick in the book to turn a property owned for a few weeks into a tax benefit for the investor.
Certain types of longer-term real estate investing, particularly in commercial real estate, can also reward the investor who’s willing to get their hands dirty. Work gives structure and meaning to people’s lives, and working for yourself by becoming a real estate investor tends to involve a great deal more structure and meaning than clicking “buy” or “sell” in an eTrade account.
Want to be rich? Think like the rich!
There are a lot of tangible reasons to invest in real estate, not the least of which is diversification. But there are also a lot of reasons to view real estate as a special class of investment.
The wealthiest households in America don’t favor real estate blindly. They’re making a calculation that real estate is the best investment because of its rare combination of upside, stability, tax benefits, and flexibility.
The good news is that you don’t have to be rich to invest in real estate. If you don’t have the capital for a big down payment on traditional real estate, non-traditional options like REIT’s are gaining traction, and they often allow you to get in on the action with a lot less capital.
There’s no doubt about it — not all investments are created equal. As Carnegie said, the wise wage earner should recognize real estate for what it is — a path to long-term wealth.