12 Benefits of Investing in Real Estate (Plus 6 Potential Downsides!)
By Michelle Clardie on 04/28/2024.
Reviewed by Josefin Gatsby
Real estate is a well-established millionaire-maker. Andrew Carnegie famously asserted that “90% of all millionaires become so through owning real estate.” And, while the world has changed since Carnegie’s era, real estate continues to be among the most popular ways millionaires invest their money.
But why? What makes real estate such a great investment?
Then, to give you a more complete picture of real estate investing, we’ll also look at the potential downsides. And we’ll explain how you can mitigate those downsides for better investment results!
12 Key Benefits of Investing in Real Estate
Want to know why so many investors focus on real estate investing? Here are 12 reasons why real estate is among the best investment options available.
Build-to-rent homes: homes that are designed and constructed as long-term rentals.
Affordable housing developments (like Section 8 housing): building new structures or converting existing structures into subsidized housing for those in need.
Real estate syndication: similar to crowdfunding, but with a more formal ownership structure that gives you a stake in the underlying real estate.
With so many varied options, there is a suitable real estate investment model for everyone.
2. Income Generation
One of the biggest benefits of real estate investing is the ability to generate income through recurring rental income and/or proceeds from the sale of a property.
This income can be used to enhance your lifestyle or fund your retirement. You could also reinvest this income to grow your real estate portfolio faster.
3. Appreciation
Real estate generally grows in value over time in a process known as appreciation. For example, our 2024 analysis of the Los Angeles housing market found that the median home price in LA increased by 46% from November 2018 through November 2023. This represents an average appreciation rate of 9.2% per year.
Appreciation significantly affects the return on investment when properties are sold. Using our Los Angeles example, if you bought an LA home in November 2018 at the median price of $702,000, and sold it in November 2023 at the median $1,025,000 sales price, you would have seen $323,000 in appreciation.
Deduct mortgage interest, property taxes, and operating expenses for an investment property from their taxable income.
Claim depreciation deductions, which reduces tax liability during the standard proration period.
Consider profits from the sale of a property held for more than a year as long-term capital gains, which come with a lower tax rate than earned income.
These tax benefits reduce the amount an investor pays in income taxes, which adds to the financial bottom line.
5. Leverage
It’s extremely common to use some form of debt financing when investing in real estate. For example, if you buy a second home as an investment property, you’ll probably cover the down payment out-of-pocket, and finance the rest of the purchase with a mortgage.
This debt leverage allows you to control a valuable asset by paying only a portion of the total value upfront. No other asset class offers leverage like real estate!
6. Inflation Hedge
Since real estate and inflation have a direct relationship, you’ll typically see property values and rental rates rise as inflation rises. This means that real estate investments act as a hedge against inflation, protecting the value of your money.
Just as importantly, inflation devalues your mortgage debt. Every dollar of debt you have following a period of inflation is worth less today than when you accepted the loan.
7. Diversification
If you’re only investing in traditional securities (like stocks and bonds), adding real estate to your portfolio can mitigate your overall risk. Having all your investments tied up in one asset class is risky because a single economic shift could negatively impact your entire portfolio. By diversifying into different investment vehicles, you spread your risk across different classes. So, if one asset class tanks, another can help bolster your overall portfolio.
8. Equity Building
As you (or your renters) pay down your mortgage debt, you build equity in the property. Over time, as rents increase and your mortgage payments remain fairly stable, you’ll see higher profit margins. Eventually, you might own the property free-and-clear, which would see a lot more of the rental income going directly into your pocket.
Additionally, equity can be leveraged for cash as needed. For example, you might decide to take a home equity loan or home equity line of credit (HELOC) against an existing property to help finance the purchase and/or renovation of a new investment property.
9. Tangible Asset
Real estate is a physical asset, which can provide more control and security compared to intangible investments like stocks or bonds.
Unlike securities, which can potentially drop to $0 in value, real estate always retains a level of value. Even if the structure on your property eventually needs to be demolished, the land still holds an inherent value of its own.
One option is to hire a property management company to handle the day-to-day operations of your rentals. This would cut into your returns, but it would require less of a time investment from you. Another option is to invest in real estate online through REITs, syndication, or crowdfunding. As these investments are professionally managed, you don’t need to invest any of your own time or energy, aside from the initial research to choose your specific investments.
11. Value-Add Potential
Value-add real estate investments are properties with distinct transformational potential. By renovating or otherwise improving a property, you can force appreciation, making the property instantly more valuable than the sum of its parts.
One of the big benefits of value-add investing is that you can get in and out of a deal quickly. If you’re looking for short-term real estate investment strategies, value-add projects can often be completed in under a year, at which point you can recover your initial investment plus any proceeds to fund a new project.
12. Community Development Opportunities
Real estate investments can contribute to community development and revitalization. We often see renovations or new developments encourage the owners of surrounding properties to make improvements to their own properties. This neighborhood improvement effort can potentially lead to increasing property values and rental rates throughout the immediate area.
Potential Disadvantages of Real Estate Investing
Before you decide to invest in real estate, you should also consider the potential downsides. In this section, we’ll show you six possible disadvantages of real estate investing and how to minimize or mitigate each one.
1. High Upfront Costs
Real estate requires significant initial capital compared to other investment types.
For example, let’s say you want to purchase a rental property. On a $500,000 property, your upfront expenses might look something like this:
Down payment: $100,000
Closing costs: $25,000
Initial repairs, marketing, and vacancy losses: $5,000
Total upfront costs: $130,000
Stocks and bonds, on the other hand, can be purchased for under $100. The high barrier to entry for real estate can make this an inaccessible asset class for many investors.
How to Overcome High Upfront Costs to Invest in Real Estate
You don’t have to start your real estate investment portfolio by purchasing a property on your own. There are several ways to start investing in real estate with much less money upfront. For example:
You can start investing in REITS for under $1,000.
If you already own a property, you can potentially start a house-hacking investment with no upfront cost!
2. Unpredictable Management Issues
Managing a rental property can be unpredictable. You might not have any trouble collecting rent, finding new renters, or keeping up with maintenance issues. But sometimes things don’t go as planned. You could have a tenant who contacts you over every little non-issue. Or you could have someone who falls behind on rent payments.
Dealing with tenants can be a difficult challenge for many real estate investors.
How to Minimize Management Issues
You can make management easier on yourself by conducting careful screenings for all applicants, as allowable by state law. Confirming rental history, checking credit scores, and getting references can all help you choose well-qualified renters who are more likely to take good care of the unit and pay rent on time. If you want most of the management burden off your shoulders, you can consider hiring a professional property manager.
If you want to eliminate management issues completely, you can opt for an alternative real estate investment strategy, like REITs or crowdfunding/syndication.
3. Market Risk
Like any investment, real estate is subject to market fluctuations. Property values and/or rental rates can decrease due to economic conditions, changes in market demand, or external factors like political instability.
How to Mitigate Risks of Investing in Real Estate
All investments carry some financial risk. But avoiding investments is riskier than investing. If you choose to save instead of investing your money, you miss out on all potential returns. Even worse, you would essentially lose money to inflation, since the value of your un-invested money declines as costs rise with inflation.
So it makes sense to invest despite the risk. And real estate is less volatile than the stock market, so it’s a good option for those who don’t want to take on too much risk. To minimize your risk, consider professionally managed real estate investments, like REITs, real estate-based mutual funds, and real estate syndication projects.
4. Holding Costs
Owning property involves ongoing costs such as repairs, property taxes, and insurance, which cut into profits.
How to Manage Holding Costs
There are many ways investors can keep holding costs down, including:
Keep the property well-maintained to avoid expensive deferred maintenance repairs.
Practice good resident retention to minimize vacancy losses during tenant turnover.
Incorporate low-maintenance amenities (like parking and rooftop decks) instead of high-maintenance amenities (like pools and fitness centers).
5. Comparatively Low Liquidity
Compared to stocks and bonds, traditional real estate has low liquidity. It can take a considerable amount of time to sell a property and convert it into cash, especially in slow markets.
How to Improve Liquidity in Real Estate
Some real estate investments offer higher liquidity. Publicly traded REITs, for example, can be bought and sold on the stock market like other securities, allowing you to convert your investment to cash quickly and easily.
6. Regulatory and Legal Issues
Real estate is subject to numerous regulations including zoning laws, land use controls, tenant rights, and environmental laws, which can complicate investments. These laws vary greatly by state and can even vary by city.
How to Handle Regulatory and Legal Issues
Staying informed of local regulations can help you stay ahead of legislative changes. In fact, you can often use local regulation changes to your advantage. Take California’s ADU laws as an example. Over the last decade, California has been changing laws to make it easier for property owners to build ADUs (accessory dwelling units) to ease the housing shortage. These ADUs can be used as guest houses, in-law suites, or rental units. Smart CA investors have been adding ADU builds to their fix-and-flips to maximize return potential.
How to Start Investing in Real Estate
The best way to start investing in real estate is to learn about the different options for new real estate investors and then set your priorities and expectations for your portfolio. Our article, Real Estate Investing for Beginners will walk you through the five steps you need to take to successfully start investing in real estate, beginning with your investment options.
And if you have any questions or want customized assistance, you can schedule a consultation with one of the experts here at Gatsby Investment. We focus on making real estate deals with high-yield potential easy and accessible.
You’re just five steps away from reaping the many benefits of investing in real estate!
