Andrew Carnegie famously asserted that,
“Ninety percent of all millionaires become so through owning real estate.”
While there’s no hard data to back up that claim, there’s also no question that leveraging real estate to build wealth is a tried and true path to riches. Just don’t expect it to happen overnight.
Beyond learning how to become wealthy in real estate, make sure you also understand why real estate is so effective at building wealth.
How Real Estate Creates Wealth
Real estate produces wealth in several ways, and it also helps you manage your risk as an investor.
Predictable Passive Income
Real estate makes an excellent source of passive income. You buy it once, and it produces income forever.
Moreover, it produces predictable income. Not on a monthly basis—in any given month, your expenses will vary—but averaged over time, you can predict your cash flow accurately.
That means that you can calculate a property’s return before you buy it. Learn how to forecast expenses and calculate ROI, and you’ll never buy a bad real estate investment again.
Another way that real estate makes money is through appreciation: the rise in a property’s value over time. While far less predictable in the long term than cash flow, it can still yield enormous returns.
Note that investors can force appreciation through renovations and updates. Investors who fix and flip houses put this principle to work, and in the short term, it does yield predictable returns.
Real estate investors can deduct every expense from mortgage interest to repairs to property management fees to their home office to the travel to and from properties.
They can even deduct—or more accurately depreciate—the cost of the building, and any capital improvements to it, albeit spread out over 27.5 years. Which says nothing of more advanced strategies like investing in a self-directed IRA or deferring capital gains taxes through a 1031 exchange.
A dollar saved is a dollar earned, and nowhere is that clearer than in real estate tax benefits.
You can leverage other people’s money to buy real estate.
Just as importantly, you can leverage your existing real estate to invest in new assets. Those assets could include real estate, or they could include other asset classes, a business venture, or even your living expenses if you run into a personal crisis.
Cynical people love to sling around the expression “It takes money to make money.” While largely untrue, there are times when access to capital can make all the difference in the world. By being able to borrow against real estate equity at any time, real estate investors have far greater access to capital than most.
Risk Management: Hedge Against Inflation
Not only do rental properties generate ongoing passive income, but that income rises over time.
Rents adjust for inflation. Or rather, they are one of the primary drivers of inflation, and often exceed the official CPI rate of inflation. Meanwhile, your monthly mortgage payments remain fixed. So the spread between your mortgage payment and your rent rises, generating ever greater cash flow over time.
In fact, that spread increases far faster than the rate at which you increase your rents. Say you buy a property that rents for $1,000, and you have a $500 mortgage payment. The year after you buy it, you raise the rent by 4% to $1,040. The spread between your mortgage payment and your rent rises from $500 to $540: a jump of 8%.
That ever-improving cash flow helps protect you against the insidious effects of inflation.
Risk Management: Diversification
Put all your eggs in one basket, and you’re in serious trouble when that basket drops.
Real estate values and rents do not correlate closely with the stock market. A drop in one market doesn’t necessarily cause a drop in the other, which protects you from shocks in any given market.
That means you can lean more heavily on one asset class when another one drops. For retirees with real estate income, for example, that could mean selling off some stocks when they experience high real estate expenses or deferring maintenance on rental properties during periods when the stock market drops.
Ways to Leverage Real Estate to Build Wealth
With a broad understanding of how leveraging real estate to build wealth works, the logical follow-up question is “How should I invest in real estate?”
There’s no singular best option for how to become wealthy in real estate. Each of the following options comes with its own pros and cons, so start simple and expand from there.
1. Public REITs
The easiest way to invest in real estate is through publicly traded real estate investment trusts (REITs). You can buy and sell shares in them instantly through your brokerage account.
That gives public REITs outstanding liquidity, but liquidity comes with a downside: volatility. Because these companies trade on public stock exchanges, they tend to move in strong correlation with stock markets. That in turn reduces any benefits of diversifying into real estate.
The other factor you should be aware of with public REITs is that the SEC requires them to distribute at least 90% of their profits each year to shareholders in the form of dividends. On the one hand, that means relatively high dividend yields. On the other, it limits these companies’ ability to reinvest their profits into building their portfolios, which limits their growth potential.
2. Private REITs
Another easy way to invest passively in real estate is through private REITs, usually real estate crowdfunding shares.
Like public REITs, these companies either own real estate directly or own debt secured against real estate. You can buy shares in their portfolios of either property or secured debt. But unlike public REITs, you buy shares directly from the company, rather than on public stock exchanges. That makes shares easy to buy but not so easy to sell; most crowdfunded REITs require you to own shares for at least five years and penalize you if you sell early.
But it also makes the share prices more stable and provides less correlation with stock markets. Crowdfunded REITs have more flexibility to reinvest profits and expand their portfolios, although many pay strong dividends to boot.
3. Loans Secured by Real Estate
You can also invest indirectly in real estate by lending money secured against real property.
I personally like GroundFloor for this. You can pick and choose individual loans, most with terms under 12 months, and invest as little as $10 toward any given loan.
When you wholesale real estate, you don’t actually take title to the property; you simply flip the contract.
In some ways, wholesaling is more a business model than an investing strategy. You find a good deal on a property, then you find a buyer for it, and take a margin when they flip the buyer’s contract to them.
Still, it makes a great way to enter the world of real estate investing with little cash.
5. Flipping Houses
This oldie but goodie offers a fast return on your investment. But it comes with its own risks, such as incompetent or unscrupulous contractors, delays, surprise costs halfway through the project, permit and inspection hangups, and more.
Find an experienced partner for your first flip or two.
6. Flipping Land
Less known but more profitable, land investing offers fewer headaches and risks.
Best of all, you can get started with little cash. That means avoiding the costs and complications of loans and buying for as little as $100 per parcel.
Consider avoiding the crowds and becoming an expert land investor instead.
7. Rental Properties
Rental properties can come with their own headaches, but they also come with a slew of benefits, as outlined above.
Get comfortable with calculating cash flow, working with lenders, and networking with contractors. Consider starting with turnkey properties through platforms like Roofstock before you attempt fixer-uppers.
It’s easy to get overwhelmed when you first start leveraging real estate to build wealth.
Start simple with real estate crowdfunding. Many platforms allow you to get started with under $1,000, so you can explore scaling your investments at your own pace.
From there, you can experiment with other strategies such as wholesaling, flipping properties, or rentals. But there’s no one best strategy as you learn how to become wealthy in real estate; just learn as much as you possibly can about your chosen strategy before you execute it.
How have you started leveraging real estate to build wealth? How do you plan to scale from here? Start a conversation in the forum and share your plan with the community!