It can be tempting to want to avoid investing in real estate. Traditional forms of real estate investing like buying rental properties can be difficult since they often require substantial down payments. Other forms of real estate investments like real estate investment trusts (REITs) and REIT exchange-traded funds (ETFs) have seen losses too.
The MSCI US REIT index, which tracks domestic REITs, is down 8.34% since the beginning of 2022. Regardless, real estate offers several long term advantages like tax deductions and cash flow. It’s also important to invest in the right real estate, meaning sub niches that are more likely to continue to be in demand.
Taxes play a significant role with any type of investment. Some investments are taxed at higher rates, while others are hardly taxed at all. Real estate offers many tax advantages like being able to deduct depreciation, repairs, maintenance and insurance costs.
Property taxes and mortgage interest are deductible, up to certain limits. For example, you can deduct mortgage interest on loans up to $750,000 per the 2017 Tax Cuts and Jobs Act (TJA). This act also created a limit of $10,000 for deducting a combination of state and property taxes.
Many REITs pass down common tax deductions like a 20% deduction on pass-through income through the end of 2025 to investors. President Biden has also proposed higher tax plans, including tentative $1.5 trillion individual tax increases, making it even more important to minimize tax liabilities.
Even if property valuations fluctuate, one advantage can remain more constant: cash flow. Real estate offers cash flow in the form of tenant rents, dividends and interest income. Rents increase during times of inflation, which is why real estate is seen as an inflation hedge.
Cash flow can be seen as net income or revenue less expenses. Some ways to increase cash flow include ensuring that you have low tenant turnover and quality tenants that pay rent on time and that don’t damage the property.
Investing in REITs can offer higher cash flows than other options. Per the Internal Revenue Code, REITs are required to pay out 90% of income as dividends. This explains why the average REIT yields 2.9%, which is more than double the 1.3% average yield on the S&P 500.
Invest in the Right Real Estate
The COVID-19 pandemic devastated many real estate sub niches like office buildings and shopping malls. Stores were closed during lockdowns, and more Americans started to work remotely.
Certain in-demand sub niches have the potential to yield continuing returns regardless of the economy or a pandemic.
Some of these sectors include self-storage and apartments. Self-storage is expected to bring in $49.24 billion of revenue in 2024. Also, people will need places to live, which is why apartments are usually more recession-proof than other real estate sub niches.
It seems like many investment classes have seen losses during the first half of 2022. The S&P 500 and the MSCI US REIT index have declined too. With high costs, it’s easy to question investing in physical real estate as well.
However, real estate will always be a good long-term investment for several reasons, especially because it offers tax advantages and cash flow.
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