6 reasons why real estate helps people get rich

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For most people living in Asia, real estate has been one of the ways they made their riches. Just look at the number of property developers in the top 100 lists of richest people and companies, and you can see why owning land, pouring concrete on that land and building a high rise apartment on it can yield riches.

So why exactly is real estate such an attractive asset class to invest in?

Rental potential

Owners of any type of property have the right to rent out spaces in the property to tenants in exchange for rental income. This stream of income is nothing to be sneezed at because it is recurring and generally locked in for the period of the contract.

There can be upsides gained by the landlord if there are contractual agreements to the rent stepping up 3% per year, for example.

For example, a rental agreement over 5 years could state that $5,000 is to be paid by the tenant to the landlord per month, with an annual increase of 3% every year. In year 2, the amount receivable by the landlord would be $5,150.

This steady stream of income is “weather proof”. That means rain or shine, the tenant must pay the amount to the landlord, else legal action could be taken. While tenants can break their lease, leaving the landlord with empty space, the landlord can recover substantial amounts in such an event.

Capital appreciation

The value of real estate also generally rises with the price level (inflation) in the economy. For a landlord, owning that piece of land or a building will mean he partakes in the appreciation of its value over time.

While stocks are subject to the vagaries of market sentiment, real estate generally does not suffer such volatility because it’s not actively traded (per minute, per second) on a centralized exchange. Without the frequent valuation, there is no volatility. In the long run too, because of the growth of the economy (save the occasional recession), asset values generally rise.

Real estate is usually valued on an annual, semi-annual, or in some rare cases, quarterly basis. Think about your home, do you get a property valuer to value it every year? Usually not. It’s only when you think of selling that you value it.



Inflation proof

Linked to the point above, rents and prices of real estate generally rise in line with inflation. This characteristic gives rise to real estate being called an inflation hedge.

For an investor holding on to property, the inflation hedge plays out in the form of rents rising most years or prices moving upward (when the property is valued).

Leverage

In almost all cases, property is purchased with leverage. For example, a buyer puts down $100,000 of his cash for a $1mil home, with the bank putting up the remaining $900,000. No household or buyer usually has a sum of idle cash sitting around which can be used to pay a property in full.

It is this characteristic of property being purchased with leverage that amplifies the returns to investors. On the flip side, the losses can also be amplified.

Value adding

For seasoned property investors, they sometimes buy a less-than-perfect property with the intention of sprucing it up.

Some examples could include an un-tenanted residential apartment, a shopping mall with poor trade mix, an office building that is half empty. After buying such properties at a lower price, the investor proceeds to rent out the spaces.

In this situation, the investor has a double uplift in the form of 1) buying the property at a lower price than if it were 100% occupied 2) the rental income derived from renting out the other 50% of space that was unoccupied at the time of purchase.

This form of property investing can be very lucrative if the right strategy of buying cheap properties, sprucing it up, leasing it out and then selling it is done right.



Tangible

Finally, property is tangible and that makes it vastly different from stocks, bonds, currencies and crypto-currencies. Of course there are certificates of ownership of the above-mentioned assets, but it is not tangible in the same sense of the word as property.

You generally can see, feel, smell and touch the property you purchase. This characteristic of real estate also lends itself to it having a residual value.

For example, the value of a stock can go to zero if the management destroys all value. For retail investors, they usually are left with nothing, unlike the banks which have a claim on the assets of the business. However, a property will very likely have some value (such as the value of the land, structure, fittings, furniture in the building etc) unless totally destroyed.

In this situation, property investors usually are assured of being able to sell their property for something, rather than nothing.

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2 COMMENTS

  1. Under ‘leverage’, you can expand it to:

    The leverage magnifies the gain. For the $100k downpayment of a $1m property, when the asset appreciates 10%, the capital gain would be 100%! 10%appreciation of $1m is $100k, and with the actual investment of $100k for down payment is also $100k.

    While appreciation of 10% is common with many investments, leveraging can magnify it to 100%. A return of 100% are not common which makes property investment such awesome tools. No banks will lend a million to any investors, but only for property investors. Ditto for other investment like gold, currencies et al.

  2. I think some people call that a return on equity also?

    You’re right because the property is tangible, can be seen, felt and touched by the banks (if they ever want to foreclose).

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