By Shion Li

At age 24, Brandon started a new investing strategy that would soon change his life. By age 29, Brandon retired from full-time work to enjoy financial independence. What was his investing strategy? He invested in residential real estate.

Brandon’s success story isn’t the only example of someone profiting from real estate investing. Andrew Carnegie said, “90% of all millionaires become so through owning real estate. More money has been made in real estate than in all industrial investments combined. The wise young man of today invests his money in real estate.”[1]

Because real estate is profitable, accessible, and stable, young professionals should make long-term investments in residential real estate.

Real Estate is Profitable

Residential real estate is an exceptional investment because of its multiple paths to profit. There are four ways to profit from real estate:

1. Cash flow
2. Loan paydown
3. Appreciation
4. Tax benefits

Cash Flow

The most notable way to profit in real estate is through cash flow. Cash flow is income, which comes from rent, minus all expenses. For example, when Brandon looks at properties, he buys only if the investment cash flows at $300 per month. To some, $300 may not seem like a lot, but if Brandon has scaled up to ten properties, this earns him $3,000 per month!

Loan Paydown

Brandon profits not only from cash flow but also through loan paydown. When the tenant pays rent, Brandon allocates a portion of the rent towards paying off the mortgage. As Brandon pays off the mortgage, he builds equity, which simply means he owns more and more of the home. As tenants continue to pay off Brandon’s mortgage, he continues to increase his ownership of the home, thus increasing his wealth.

Appreciation

In addition to loan paydown, Brandon grows equity in his property through appreciation, or the property’s growth in value over time. Generally, appreciation is categorized into two types: market appreciation and forced appreciation. Market appreciation happens when home prices rise without action from the investor. For example, if Brandon had bought a home in 2009 in San Francisco, California, by 2019 the home would have increased in value on its own by 90%.[2] Forced appreciation happens when investors make an improvement to their property. If Brandon adds a bedroom to his property, the property could increase in value by an additional 10%. Appreciation is a vital aspect of real estate that Brandon uses to increase wealth.

Tax Benefits

Brandon understands that increasing his wealth is pointless if he loses it to paying higher taxes. That’s where the last benefit of real estate investing comes in. While investing in real estate, Brandon can retain his wealth through real estate tax benefits. One of the biggest tax deductions Brandon receives is depreciation, or the deduction of portions of a property’s original price over its lifespan. Depreciation is considered an expense since it lowers a specific amount of income and “uses up” the life of his home each year; however,, his home still appreciates in value over time. Additionally, Brandon deducts other items such as property tax, mortgage interest, property insurance, and maintenance;[3] which has reduced his income tax obligation to $0!

Real Estate is Accessible

Having a variety of ways to profit isn’t the only advantage to real estate investing; real estate is also accessible. Initially, Brandon thought that real estate was inaccessible since he didn’t have start with a lot of money. Brandon’s parents and neighbors told him that as well, so he always believed it until he learned about leverage.

Think about leverage like a seesaw. If you correctly position the base of a seesaw, you can move 1000 pounds with just the weight of your body; you can move big objects with little force. In real estate, loans are your leverage. In Brandon’s case, he can buy and control an entire property by paying a small percentage of the home’s price. In doing so, Brandon fully benefits from cashflow, loan paydown, appreciation, and tax advantages with a relatively small down payment.

What are the types of loans? The most common loan is traditional financing which typically requires a 20% down payment. Brandon wants to buy a $100k home in Michigan, but he doesn’t have $20k for the upfront payment; however, he can use the FHA financing option, which requires a 3.5% down payment[4] as long as he passes credit score requirements, makes the home his primary residence, and pays mortgage insurance.[5] So, with a $100k home, Brandon pays only $3.5k, which is much more accessible! Brandon can also use seller financing, which is when a seller agrees to let a buyer pay for the home over a specific timeframe instead of a single payment. With seller financing, Brandon doesn’t need to use a bank, and the down payment and interest are negotiable. In rare occasions, Brandon has negotiated a deal for 0% down!

Getting started in real estate does not require great amounts of money to get started. Investors can choose which financing method is most appropriate for their situation. Brandon uses an array of financing options to grow his portfolio, and now, he is sitting comfortably on his stable real estate investments.

Real Estate is Stable

Brandon didn’t always think real estate was a stable investment; in fact, he was quite skeptical at first. This skepticism stemmed from a story Brandon heard about his distant uncle, who was involved in a shady get-rich-quick scheme but ended up going broke.

However, Brandon decided to give real estate a try because he knew that real estate was a proven method for building wealth, as opposed to the new untested business models that promise abundant success with no risks.

Through his experience, Brandon learned that one of the top reasons for real estate’s stability is demand predictability.

Figure 1: Number of rented homes (in millions) from 1975 to 2019.

Figure 1 shows that the number of renters has steadily increased over the past 44 years.[6] Rental demand hasn’t fluctuated, and the trend line shows that the demand for rental units will steadily increase.

Additionally, real estate is stable because it’s a controllable asset. When Brandon buys a rental property, he has complete control over the property’s profitability. For example, he can increase rent by adding a laundry unit to the property, and he can increase the home’s overall value by adding another bedroom or bathroom. However, if Brandon were to put his money in the stock market, he would have little to no control of the value of the stock. Real estate investors enjoy asset control, which makes real estate a stable investment.

Although real estate is a stable investment, new investors often ask Brandon, “Isn’t real estate risky?”

Real estate is a strong, stable investment, but is not risk-free. Real estate is susceptible to market crashes like the one that occurred in 2008; however, this risk can be mitigated through long-term investing.

Figure 2: Average Home Prices in the U.S. from 2003 to 2014

Figure 2 shows that although the market dipped by 20% from 2007 to 2009, the average home value recovered by 2013,[7] which shows that a long-term investment strategy is key to mitigating market risks.

Another risk to real estate investing is having harmful tenants. In the past, Brandon heard unsettling stories about uncompliant tenants who refused to pay rent or destroyed the property. While troublesome tenants are a legitimate concern, Brandon knows he can avoid this risk by thoroughly screening tenants through background checks. Remember, real estate is a controllable asset, so investors can choose which tenants to accept. Investors avoid risks associated with harmful tenants by choosing solid tenants whose records show that they are responsible, trustworthy people.

Conclusion

Brandon’s experience shows that residential real estate investing is profitable, accessible, and stable. Through real estate, Brandon has achieved financial freedom and plans to continue his real estate investments.

Brandon’s story isn’t an anomaly; it can be your story too. Like Brandon, you can gain financial independence through real estate investing.

That is why young professionals like you should make long-term investments in residential real estate. When you graduate from college, make your first home a rental property!

You’ll instantly be on the road to financial independence and if you do it right, you may end up retiring at age twenty-nine like Brandon!

---

Notes

[1] “20 Famous Real Estate Investing Quotes,” Realty Mogul, https://www.realtymogul.com/knowledge-center/article/20-famous-real-estate-investing-quotes.

[2] “Increase in home value in selected neighborhoods in San Francisco between 2009 and 2019,” Statista, July 2019, https://www.statista.com/statistics/1023049/san-francisco-neighborhoods-with-largest-home-value-increase/.

[3] “Tips on Rental Real Estate Income, Deductions and Recordkeeping,” IRS, https://www.irs.gov/businesses/small-businesses-self-employed/tips-on-rental-real-estate-income-deductions-and-recordkeeping.

[4] ”Let FHA Loans Help You,” HUD, https://www.hud.gov/buying/loans.

[5]Troy Segal, “Federal Housing Administration (FHA) Loan,” Investopedia, updated October 26, 2020, https://www.investopedia.com/terms/f/fhaloan.asp.

[6] “Number of renter occupied housing units in the United States from 1975 to 2019,” Statista, March 2020, https://www.statista.com/statistics/187577/housing-units-occupied-by-renter-in-the-us-since-1975/.

[7] “Average Sales Price of Houses Sold for the United States,” FRED Economic Data, Federal Reserve Bank of St. Louis, accessed Nov 3, 2020, https://fred.stlouisfed.org/series/ASPUS.