Why Invest in Real Estate?

Welcome to my first blog post!  Let’s start by explaining what we do at Pear Tree Property, and why we do it.  We invest in Rural Rental Real estate. I thought it would be “fun” to take a look at each of these three R’s.  So let’s start with the question: why should you invest in real estate?

You Can Actually Touch It

If I go buy a stock, what am I actually buying?  Well, at the end of a day, it’s a piece of paper.  Back in the day it looked a bit like this:

Investing in stocks

Can you derive some pleasure out of a piece of paper?  Maybe…?  Only if it’s construction paper and you’re the first person to cut it.

Technically speaking of course, the stock certificate gives you some ownership in a company, which may pay a dividend and increase in value.  But you still can’t really “see” a company.  The best you can do is look at it’s headquarters (real estate) or people.

When I invest in real estate, I can swing by the home whenever I want.  Is it in good condition?  Well all it costs me is a bit of gas money to figure that out.  Answering the same question about some stock requires a degree in accounting and/or a lot of time poring over prospecti/earnings/balance sheets/etc.  Even then there are so many accounting practices a company might use, or misuse, that it’s tricky to get the full picture (Enron anyone?).

But Kenny!  You’re forgetting about other investments you can touch (tangible assets).

Let’s take look at gold:

Investing in gold

Oooooh, sparkly.

A former gold bug colleague once made a compelling argument for buying gold.  Back in Roman times a well made toga cost about an ounce of gold.  Today, a really good suit costs about…an ounce of gold (worth a bit less than $1400 as of this writing).  Talk about holding it’s value!

So if your ancestor had an ounce of gold, today you would have….nothing!  Somewhere along the line someone probably would have stolen it.  Alternatively, you might have paid to keep it secret, keep it safe and that storage would have cost you at least what that gold is/was worth.  In the biz, they like to call this a depreciating asset.

Real estate not only maintains it’s real value, but if you invest in the right real estate you can make “real” money.  Not to mention the “keeping it safe” cost is ultimately footed by the US Army.  Go try and steal a house, I’ll come around so you can tell me how it went through a phone on the other side of some soundproof glass.

Local Knowledge Benefits

Local knowledge is everything when you invest in real estate: the better you know a market and the people involved, the better deals you’ll find.

Does in depth analysis of the stock market give you a similar advantage? If you’re Warren Buffett, apparently the answer is yes. However, if my finance background has taught me anything it’s that that space is massively crowded, the competition fierce, and the chances of finding true edge small.

Think the professionals who live and breathe the market have it any easier?  A former boss once told me: “The only difference between a professional investor and a amateur investor is the fees.”

If you’re looking for a good book, “Fooled By Randomness” expands on this topic

On the other hand, when you invest in real estate you only have a limited number of participants in your geographic area.  If you’re in a rural area you’ve even less competition, but I’m getting ahead of myself.

Tax Advantages

If you’re looking to minimize your tax burden, it’s hard to beat investing in real estate.  Unless of course you’re Dutch and like Sandwiches.  Every year to date our holdings have shown a tax loss even though we’re getting quarterly checks!

How is that possible? It’s simple: tax fraud.

Just kidding.

When you invest in real estate you gain a lot of unique tax advantages. Here are a few.  If you read tax code for fun like me, you’re correct in saying the following is overly simplified. I plan to flesh this out a bit more in future posts, so you’ll just have to wait with abated breath until then.

Depreciation

So you bought a house? Well congratulations, it’s now losing value! Or at least that’s what the IRS allows you to claim. It’s called depreciation. The underlying assumption is that any home you buy slowly falls apart and you’re left with nothing but a plot of land in 27.5 years. Now, there’s a whole lot of evidence to the contrary, but when you file your annual tax return you get to subtract 3.636% (100/27.5) of the home’s value from your income. Who said the IRS wan’t generous?

Capital Gains

Let’s say you bought a house four years ago for $100 and solid it today for $150? What then?

First, a $100 house?!  Does it look anything like this?

Invest in real estate

Second, you now have $50 in long term capital gains (LTCG).  The tax rate on LTCG is 15%, or $7.5.  You can handle that burden in one of two ways:

  1. Pay the IRS $7.5 and buy a small popcorn at the theater.
  2. Buy more property with the full $150 and not pay taxes until you sell that property (unless of course you decide to buy more property with those proceeds).

You do the second through what’s called a Like-Kind Exchange (or 1031), and it’s a great way to grow your empire without having to pay the tax man every step of the way.

Drawbacks of Real Estate

If it was easy, everyone would do it.

There are some downsides when you invest in real estate.

For one, you can’t sell it in under a microsecond for $5.  The process can span months and normally will cost you 6% in selling commissions alone.  Do try and buy the right property the first time cause you’re going to have it for a while.

It’s a pain to manage.  Finding tenants (if you’re doing rentals), property taxes, income taxes, maintenance, etc, etc.  Unless you want to spend a ton of time on this, you’re going to want to find someone to handle the headache for you.  Lucky us.

Wrap Up – You Should Invest In Real Estate

When you invest in real estate, you’re getting something tangible, you benefit from local knowledge, and you get amazing tax benefits.  One thing to note, I keep saying you should invest in real estate.  I didn’t say I think it’s worth your time to start buying it personally.  Check out my post on why I think this is a bad idea.

Hopefully at this point you’ve bought into the fact that you should invest in real estate.  In the next blog post, I’ll talk about a specific type of real estate: rentals.

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During Kenny's decade in finance he bought many single family rentals in rural areas, as a hobby. Along the way, he talked some brave souls into joining him as investors and recently retired from finance to take his hobby to the next level. Keep up to date with everything he's doing on twitter!

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