I will discuss the ten key reasons why investing in real estate is beneficial. This column will cover the first four points. The next column will continue with six more.

1. Attractive Return on Investment (ROI )
The potential for an attractive return on your investment is very high in real estate, especially taking into account an increase in property capital gain and positive revenue cash flow income.

Historically, real estate has increased in value greater than inflation and many other forms of investments.
Depending on the geographic location and type of property investment, the gains are frequently double-digit and sometimes triple-digit. Through the application of financial leverage, the net returns in cash flow and property appreciation can be considerable.

Example: If the investor puts ten per cent down and borrows 90 per cent of “other people’s money” (for example, lender financing), the return on investment (ROI) is calculated on the actual amount the investor contributes of their own money. Using this formula, the ROI can be immense. For example, if an investor buys a $200,000 house for investment with ten per cent down payment ($20,000) and a 90 per cent ($180,000) mortgage, and the property doubles in value ($400,000) over five years, the equity increase would be $200,000, or $150,000 net after capital gains tax. This would represent a 750 per cent return over five years or 150 per cent ROI annual average over the original investment of your own money of $20,000. Also, the mortgage debt would have been reduced over the five years, providing even more equity.

In the example above, there would be no negative debt financing required by the investor, as there would be break-even of expenses over income. However, if the investor was astute and well informed, there should be positive cash flow. This would mean that the actual average annual net ROI (after tax) of the investor would be greater than 150 per cent annually on the original investment of $20,000. In addition, the fact that there is a positive cash flow is one factor that automatically increases the value.

2.  Tax Advantages
There are numerous types of tax advantages to investing in real estate, whether you have a principal residence or investment income property.

Example: All the interest you would receive from a bank account, term deposit or GIC is fully taxable as income. If you are obtaining interest of four per cent on your deposit (the nominal rate) on your deposit, and the inflation rate is three per cent, the “effective” or “real” rate of return is one per cent. If you are paying tax at a 35 per cent rate, then effectively you are breaking even, or possibly having a negative return on your money.
In practical terms, taking inflation and taxes into account, you have lost on your bank deposit investment. Equity investments in the stock market have a degree of risk, depending on the nature of the investment, of eroding the principal and having no positive return.

Benefits include:
>> Tax-free capital gains on a principal residence, (for e.g., if you bought at $50,000 and sold at $550,000) the net gain of $500,000 is yours to keep
>> Ability to write off rental suite income against a pro-rata portion of your home-related expenses (such as mortgage interest, property taxes, utilities, maintenance, insurance, etc.)
>> Ability to write off a portion of your home-based business income against a portion of your home-related expenses
>> Reduced tax rate of 50 per cent of capital gain from investment real estate
>> Flow through of losses from negative cash flow against other sources of income
>> Deduction of real estate property investment expenses against income
>> Write-off of depreciation of building against income

3. Low Starting Capital Using Principle of Leverage
This concept simply means putting in a small amount of money and borrowing the rest—using “other peoples’ money.”  Many people have become millionaires by applying this principle.

Example:  If you put a down payment of ten per cent and borrowed 90 per cent, this is called high-ratio financing. Basically the ratio is 9:1; that is, nine times as much money was borrowed as was invested personally. This is a common format. The risk to the lender is low or non-existent, as the property is the security. In the worst case scenario, if the lender has to sell due to the default of the borrower, the net proceeds after sale should at least cover the amount of the mortgage, especially considering the historical appreciation in value.

A related concept to leverage is the concept of pyramiding. In this strategy, you would borrow on the increasing equity (due to appreciation), of your existing properties, applying the principal of leverage to buy even more properties over time.

4.  Low Risk
Any investment has potential risk, and you can, indeed, lose money in real estate. However, there are reasons why someone might lose money in real estate. These reasons are predicable, and can be avoided or minimized.

Real estate has traditionally been a secure, stable investment compared to other investments, especially if one buys prudently and with advance knowledge. Today’s current low interest in fixed-term investments is causing investors to consider other options. An investor might be concerned about the equity stock market risk, recent negative experiences with certain categories stocks, or low returns. A buoyant economy with the attendant sense of confidence in one’s employment, and natural comfort and affinity for real estate, is another factor contributing to the real estate investment environment.

Example: There are various reasons for the relatively low risk, which naturally will vary depending on the geographic area, desirability of location, stability of the market, and other factors. These factors include: population increase; less land available; up to 50 per cent renters in metropolitan areas; low interest rates; ease of financing for highly-leveraged property; intrinsic need and demand for residential real estate; and consistent history of land value appreciation exceeding the rate of inflation. The real estate market is cyclic and, depending on location and other factors, eventually will increase in value.

In the next column, I will discuss six more benefits of real estate investing. CL



--
Excerpted with modification, from 101 Streetsmart Condo Buying Tips for Canadians, by Douglas Gray, published by John Wiley %26 Sons in May, 2006. Copyright  2006 by Douglas Gray. All rights reserved. Any reproduction of this material without the author’s advance written consent is prohibited. The author assumes no responsibility whatsoever for any information provided above, as the purpose of the column is for general information only, and not intended to provide professional advice.