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Your Wealth Creation Arsenal: The 7 Reasons Why Real Estate ...


Published in May 24th, 2008
Posted in Real Estate & Property

Real estate (both residential and commercial property) is perhaps the best way for the average person to generate wealth. There are many reasons why real estate is such a brilliant way to fast-track your wealth plan and why it’s so popular with those who want to become wealthy or are already wealthy. The key ones are:

1. Income and capital gain
2. Financial leverage
3. Low volatility
4. Below-market purchases
5. Add value
6. Ability to extract cash that is tax-deferred
7. Simple

Let’s look at each of these advantages.

Income and capital gain:
Real estate offers investors the ability to gain on both income and price appreciation. Income comes in the form of rentals and investors’ benefit from rental increases over times, which are usually in line with inflation or wage growth. This means that those who hold properties over the long term can experience significant increases in the income their properties produce, while mortgage payments remain constant.

Investors also benefit from the capital growth in the value of their properties over time, while their mortgage either stays the same (interest only) or reduces (repayment mortgage). This is usually a slow, constant growth rate that reflects increasing demand due to inflation and population growth. One of the wonderful things about capital growth is that it’s unrealized income and as such you don’t pay tax on it until you realize it…i.e. sell your property.

Financial leverage:

Financial Leverage, also known as gearing, allows you to control assets far beyond and much earlier than by using your own money. Real estate is quite unique in that those with money, namely banks, are more than willing to lend you their money for property investment. Turn on the TV, open up a magazine or walk down a main street, and you’ll see ad after ad for financial institutions offering to loan you money for a home loan. When compared to all other asset classes, property stands alone. Why? Because banks consider property a low-risk asset.

The key benefit of gearing is that for every dollar you invest you control more assets…assets that are paying an income and growing in capital value.

Let’s say you’ve managed to save $15,000 and you wanted to compare stocks and property as two investment alternatives to see how they stacked up. Well, for stocks your $15,000 would buy $15,000 worth of stocks as gearing is both difficult and fairly risky. For real estate however, it’s quite simple to get 85% leverage on residential property, which would allow you to purchase a property worth $100,000.

Assuming that both stocks and property increase in value by 5% per year and the income from your property covers all your interest costs and running expenses (which it should if you’ve positively geared), how do they compare?

Both stocks and property have produced the same return on the invested capital. i.e. 5%. However, this does not represent the return that you receive on the cash you’ve invested. The return on your cash using stocks is still 5% as there is no gearing, but your return on your real estate is actually 33%. This is why a direct comparison of returns between stocks and real estate is totally pointless. You need to take into account the effects of gearing. Financial leverage is one of the key reasons why using property is so powerful since you can use OPM to multiply and fast-track your wealth plan.

Low volatility:

Volatility is generally considered the normal measure of risk. The wealthy do not agree entirely with this assessment of risk, but for the purposes of this analysis well stick with this version of risk (for the wealth creation view of risk visit the Risk category). If you were to compare the market index like the Dow, S

emlyn scott is the founder of rich1percent, investor and wealth creation author. he is a wealth creation and finance expert with 4 post graduate qualifications and has amassed a multi-million dollar investment portfolio.