Inflation-Indexed-Income, Appreciation, and Disciplined-Wealth-Preservation
In a future post I can lay out the math of real estate investment using IRR (internal rate of return), and show tables over time as you’ll frequently see in detailed real estate prospectus.
But math aside, I think there are 3 fundamental reasons to invest.
Caveat: All real estate investment depends to some extent on regional population growth, and upward, or at least stable levels of earnings per local resident. (more on that in a future post)
Inflation Indexed Income
In a stable local economy, with a property that has attributes equally popular, income from a property should track the general inflation rate…it can do better with appreciation, or worse in an area with decreasing economic activity..but your “neutral” is quite good indeed.
Prices to build competing space will go up to provide some safety from competition, the amount of money businesses bring in that underlies their ability to pay rent will rise with inflation over time.
As an investor who might be depending on income in retirement, you can feel safe in spending the income, after maintenance from a building and knowing you won’t be falling behind.
Tax Aspect: There is a big advantage in having your money invested go up in value without being taxed. If you were able to get an 8% return on a bank deposit and you were a higher income earning person typical of a real estate owner you’d need to pay nearly 50% in taxes, state and federal, if you live in California. That would leave you with 4% income however if we have 2 or 3% inflation you better put at least that much back in your account to keep up… only 1 or 2% spendable even if you got that really high(for today) 8% interest income.
In a stable Real estate environment, even with income properties demanding a high multiple of annual rents (see future post on multiples) you’re bound to do better. Comparing real estate investment to the stock market indexes is more complex and worthy of another full post.
Appreciation
If you are looking at a place like Marin County, (or West LA, or Lake Tahoe, Carmel, La Jolla as other examples) people are going to chose to live here for access to amenities, barriers to entry for those with social problems can lead to perceptions of safety whether warranted or not (but crime rate data does support a relative safety argument). Natural beauty, access to open spaces, short commute to high paid jobs, excellent schools all tend to create a demand that goes hand in hand with economic growth of our nation.
To some degree accumulated wealth of generations also creates a competitive bidding. When people with all the money in the world choose a place to live, Marin is a consideration, as are some of the others I’ve mentioned.
Inflation is based on a basket of goods…even if you could get inflation plus the few percent in productivity gain increase that makes GNP rise quicker than the CPI inflation over time… you’re getting real Appreciation. The bidding war can even out-pace that…., in other words your wealth would be increasing after inflation even while spending all of the net income the properties produce.
I delve further into the appreciation potential specific to property types throughout the topic sections on the site. Some types of investment properties should be more resilient than others.
Disciplined Wealth Preservation
It’s harder to make a stupid mistake that cost stock market investors large hunks of what they could have potentially made “if they just held on” (especially when they need to pay taxes on gains). It can be hard to rest easy at night when what is on the news worries you, and also easy to sell it all and wait for lower prices that don’t come along.
For better or worse Real Estate isn’t very liquid…even the most liquid investments, homes, will take you a month or two to sell between decision, preparation and closing. This lack of liquidity does keep you from getting a rapidly vacillating quote on your net worth.
It does make it easy to hold on and keep your idea of value as what things have been selling for over a year, not day to day on the news cycle.
If you’re owning real estate for the long haul, you’ll be looking at your income, not the sale value of your real estate anyway.
Forced Discipline of not easily being able to spend more than your investments are making has a huge positive effect given the realities of human nature. That over budget vacation doesn’t leave you poorer as easily if you didn’t think you had something to dip into in the first place.
I believe that the reason so many long term real estate investors are wealthy is that they’ve had it easier not to go wrong. Lack of liquidity might be a two edge sword, but the edge leans in favor of growth in wealth, not frittering it away.