If you are reading this article, you are probably aware that real estate is one of the most reliable investments, both in the short and long term. There are several benefits that come with putting your money in real estate when compared to most passive investment alternatives. However, real estate investment also has some risks that you need to be aware of as an investor before moving forward.
In this article, I will take you through both the rewards and the risks of real estate investment. By the end of the article, you will have a clear idea of what you are getting into. Without any further ado, let’s get into this.
The annual return rate of real estate properties is usually between 10 to 15%. That means your real estate property is likely to double in value in less than 10 years, making it one of the most profitable and reliable long-term investments. In addition to appreciation, the rental income of the properties also increases by about 3% per year.
One of the main reasons people invest in real estate is to create a regular and stable source of income. In addition to the annual appreciation, investing in rental properties will enable you to earn monthly income. Most rental landlords charge monthly rent that is equivalent to 0.8 to 1.1% of the property value. For instance, if your property is about $300,000, your monthly rental income should be around $2,400 to $3,300.
As we shared earlier, the annual return rate of real estate properties is usually above 10%. The inflation rate in the USA and most developed economies is usually below 5%. That means your real estate assets will still have gained value even when you factor in inflation. Any investment with an annual return rate that is less than 5% will be less in value when you factor in the annual inflation rate.
Among the underrated rewards of investing in real estate are the tax advantages. Real estate investors can deduct the annual depreciation rate, maintenance costs, property tax, insurance, and mortgage interest from their annual tax bill. These deductions can be very significant when compared to taxes the investor would pay if they had invested in another kind of asset.
It should also be noted that rental income is not classified as earned income, so real estate investors don’t have to payroll taxes. Also, when the property owner finally chooses to sell their property, the money generated is not taxed as income. It is taxed as capital gains, whose tax rate is usually less than income tax.
When you buy a real estate asset such as an apartment or land, you may choose not to be involved in any of its operations. Most real estate investors use property managers to take care of all the management issues of their properties, including ensuring that all tenants pay on time and that the property is in the best possible condition.
If you ever need money to invest in another business or take care of your personal needs, you can use your real estate property as collateral to get a loan. The monthly rental income can be used to pay off the monthly or annual payments of the loan. Most real estate investors have used the leverage of real estate properties to build empires.
Before you choose to invest your money in real estate, here are some of the risks that you need to be aware of;
Real estate properties generate money from monthly rental income from tenants. That means this income largely depends on the tenant’s trustworthiness and willingness to make payments on time. Your property can turn into a nightmare if you get stubborn tenants that don’t want to pay their rent on time.
Some tenants can also maliciously vacate if they are not well monitored by your security, which obviously leads to a loss of rental income. Some investors deal with this risk by insuring their properties. However, this is an additional expense that you may not have to pay if you choose to put your money into some other investments.
The value of any given property usually depends on the activities within its neighborhood. For instance, houses in a given area may increase in value if a certain company that employs thousands of employees comes into this area. However, these properties may also lose value if this same company closes its operations in that area.
Most real estate investors finance the acquisition of their properties using borrowed funds as the main source of capital. These investors hope that the property will be able to generate enough money to finance the payment of the acquired loan. However, this is a huge risk because there are certain times when the property may generate less money than the required annual or monthly payments for the loan.
Some factors, such as vacancy and a drop in property rental value, could affect your ability to make period debt payments. It is always best to do your calculations right before deciding how much borrowed money you should use when acquiring a property. Most experts recommend borrowing a maximum of 80% if you want to easily fund the debt payments using income generated from the rent.
When buying a real estate property, most investors assume that it will be occupied to full capacity or close to full capacity at all times. However, there are certain periods when a significant section of the property may be vacant. This could be due to changes in the area where the property is located that may force some tenants to vacate. It could also be due to unprecedented disasters like the covid19 pandemic that forced many businesses to close.
Real estate investors need to keep a close on the government policies related to their sectors. For instance, a change in property-related taxes could affect the overall income generated from a real estate investment. As a real estate investor, always take time to read about any government policy changes to find out if some could directly or indirectly affect your income and operations.
Those are some of the common rewards and risks that any potential real estate investor needs to know about before putting in their money. Despite the risks, real estate is still a very reliable investment if you do it right. The investor needs to figure out solutions that will allow him to overcome the above risks. Getting insurance is one of the ways to deal with some of the above risks.
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