Several years ago, Dr. Robert M. Doroghazi, a noted cardiologist, wrote a book entitled, “The Physicians Guide to Investing.” Warren Buffett, chairman of Berkshire Hathaway, said it should be “required reading at med schools.” Dr. Doroghazi makes these important points when it comes to investing: (1) “Real estate should represent a significant position in every investor’s portfolio; and (2) “…real estate should be a core holding” in a person’s investment portfolio.
What is it that makes real estate such an important investment that every high net worth investor, not just physicians, should consider real estate as a “core holding” in in their investment portfolio? Here are several key reasons why real estate should be a “core holding” in “every investor’s portfolio.
First, real estate has “traditionally done well and will continue to do well in the long term.” As Mark Twain once said, “Buy land, they’re not making it anymore.” Real estate is a tangible asset compared to the ownership of a stock. You can feel the bricks and mortar. You don’t have to wonder if it’s going to be there when some “bone-headed” CEO makes a bad decision that materially drives down the value of the company’s stock.
Second, real estate performs well in an inflationary environment. One of the fundamental economic conditions in the United States is the need to always keep the economy growing. If the economy is not growing 2-to-4 percent a year, our leaders are not happy. Why? Because it’s difficult to pay the debt these “leaders” have racked up if the economy isn’t growing. It allows the government to pay debt with cheaper dollars.
In 1969, the price of a gallon of gasoline was $0.29. Today, the average price of a gallon of gasoline is $2.70. That’s an average price increase of 4.56 percent a year for 50 years! Put another way, $1.00 today will be worth $0.41 in 20 years. Unless you have a hedge against inflation, your purchasing power will be less when you retire.
The benefit for real estate investors is that real estate continues to appreciate-in-value over time, thus keeping pace with inflation. Rents go up to keep up with rising expenses. The mortgage, on the other hand, is usually a fixed cost and amortized over time using cheaper dollars.
Third, real estate investors experience positive leverage. An investor can invest 25% in cash and can borrow the remaining 75% from the bank at a rate that is less than the yield on the asset. Here’s an example of positive leverage. Say you invest $250,000 in commercial income-producing real estate, you can purchase a $1,000,000 property because the bank will lend the additional $750,000 to acquire the asset.
That means, if your investment appreciates at 4% over 10 years, your asset grows in value to $1,480,000. With the reduction in loan principal, which is paid by the income you receive from tenants, your equity grows from $250,000 to $925,000, an increase of $625,000 or 270 percent! For every dollar you invest, you can purchase four dollars’ worth of real estate.
Fourth, there are significant tax advantages when purchasing real estate. An investor can depreciate the value of the asset which decreases the net income on which taxes must be paid. Therefore, taxes are paid on only a fraction of the cash flow received. Also, when the real estate investment is sold, taxes are paid on the sale at a much lower tax rate than the rate paid on ordinary income, generally 15-to-20 percent compared to 39.6% for federal taxes plus state taxes, depending on that state you live in. The government also permits you to defer the gain if, when you sell the real estate investment, you do a 1031 Tax-deferred exchange.
In summary, income-producing real estate should be a “core holding” in “every investor’s portfolio” for the following reasons: (1) real estate is a tangible asset that grows in value when held long-term; (2) real estate keeps pace with inflation which maintains the value of your dollars over time; (3) real estate creates positive leverage by allowing you to buy $4 dollars of asset for every $1 invested; and (4) real estate provides favorable tax benefits in the form of depreciation, capital gains, and even tax deferment. Thanks to Dr. Doroghazi for pointing out some of the many advantages of investing in income-producing real estate.