Why is real estate (arguably) one of the best investments?
One word: leverage.
Property in many markets come with a level of security that other investments don\’t have. That security is the high level of likelihood that property will not only be a good store of value, but it will continue to appreciate in value over time.
Because of that security, it is easy for people to get leverage. If you have a decent job, banks will lend you typically 5 to 20 times (with you putting down a 20% down to a 5% down payment) the amount of cash that you have in the form of a mortgage to buy real estate.
Banks are allowing you to use their money to buy the property, but you get the full benefit of the property value increase over time!
Let\’s compare two investments: stocks and real estate.
Example: Bob and Joe both have $40,000 in savings. Bob invests in stocks and Joe invests in Real Estate.
Bob follows the advice of many and puts his $40,000 into index fund using his self-directed trading account. He has the option of using a margin account but he is hesitant because beginner stock investors are not advised to use margin or options. His investment grows at about 7% per year, and so in 5 years his investment is worth $56,102. Bob\’s increase in net worth is approximately $6,000.
Joe follows the advice of his rich uncle and puts his $40,000 into a brand-new build. He is hesitant because he knows he can get a better deal if he buys a used investment property, but he isn\’t handy. His $40K makes a 20% deposit on a $200,000 condomium. The condominium appreciates in value by about 7% per year, and so in 5 years his investment is worth $280,510. Joe\’s increase in net worth is approximately $80,000 because he took advantage of the leverage that banks offer individuals.
Now it is evident already that there is a significant difference between Bob and Joe. But let\’s take this a step further and use some fancy terminology to describe why Joe\’s investment is better than Bob.
Return on Investment (ROI) = (FVI−IVI)/Cost of Investment × 100%
Where FVI is Final Value of Investment and IVI is Initial Value of Investment.
Bob\’s Return on Investment (ROI) is (56102-40000)/40000) = 40.2%
Joe\’s Return on Investment (ROI) is (280510-200,000)/40000 = 201.3%
Conclusion: It\’s not difficult to come up with an example where a real estate investor can realize gains 5x greater than a stock investor because real estate investors typically use 5 to 20 times leverage just by using a standard house mortgage, while stock investors typically do not do this.