What is Wealth Building Through Real Estate

Real estate is widely known for the diversity that it brings to an investment portfolio, considering that it’s not correlated to stocks and bonds. However, real estate brings so much more than that to an investment portfolio and is one of the few asset classes that can help investors build generational wealth.

There are various strategies that investors can employ to build wealth through real estate, each offering its own set of features that can help you reach your long-term goals. According to a CNBC survey, almost?25% of Americans believe that real estate is the best path to wealth building, surpassing stocks, business ownership, or side gigs.

There are a host of benefits associated with real estate investing. Considering real estate’s independence from stocks and bonds, coupled with its low volatility, it is one of those markets that can strengthen an investor’s risk-reward exposure and generate wealth for individuals and families over time.

In addition, real estate can potentially protect an investor’s wealth in a high-inflation economy like the one unfolding now. In addition to building wealth, real estate can protect an investor’s capital gains through tax efficiency. It may take patience and a winning strategy, but if you strike the right equation, real estate investing can help you build the wealth you desire for greater financial freedom.

Understanding Real Estate Wealth Building

Wealth building is a concept that means generating ongoing income over the long haul through various channels, not a salary. Instead, wealth building is a way to attain financial freedom that not only changes someone’s life but also that of generations to come. Real estate is a key source of wealth building, whether you are a novice or a sophisticated investor. Consider looking into Proptech, for example.

While there is a wide range of ways to generate income and protect one’s capital through real estate investing, one common denominator is that it generally requires time. With real estate, the longer you hold onto an asset, the more wealth it’s likely to generate for you, according to property investor Michael Zuber cited by Business Insider.

He explains that:

“It’s amazing what happens to a portfolio after you’ve owned it for ten years.”

Whether you’re collecting rental income, flipping houses, using Proptech, or investing in a fund, history shows that time is on your side when you invest in real estate.

The Power of Real Estate Investment

To understand the role of real estate in wealth building, it helps to examine the past performance of the industry. It’s also important to keep in mind that past returns aren’t a promise of future performance. Having said that, the numbers don’t lie.

Take rental properties. According to a study by Arrived.com, which measures real estate investing in the 20 years leading up to 2021, real estate investing is hard to beat. The data show that by investing in leveraged single-family rental homes over those two decades, investors would have seen returns of 11.7% on an annual basis.

The return model is two-pronged, comprising both the property’s value growth and a stream of rental income. So as the value of the property expands, the owner of the property sees their equity in that asset grow, too. The returns are more attractive if the owners can finance the purchase with an attractive interest rate on a mortgage.

In addition, this owner will receive a steady stream of rental income on the property, the second leg of the return model. Tenants are required to pay rent every month. Once the owner pays expenses, the remainder of that income becomes cash flow to them.

According to The Motley Fool, REITs in the sub-storage category have generated annualized returns of nearly 19% between 1994 and 2021. REITs in the infrastructure and data center segments have similarly outperformed the broader stock market. In the past decade, the more overall stock market has produced a compound average annual growth rate of less than 11% yearly.

In comparing real estate returns vs. the S&P 500, real estate shines, especially over the long term. Take real estate investment trusts (REITs), which trade like stocks in the public markets. REITs have outperformed the S&P 500, a broad measure of the stock market, over the past couple of decades. Not only that, but REITs exhibit less volatility than stocks, so investors can expect more excellent stability in their investments.

If you want evidence of wealth building in real estate, consider that in the ten years leading up to 2022, owners of single-family dwellings generally earned $225,000 in housing wealth over that period.

Building a Foundation for Wealth

For a fair shot at wealth building, the first step to take is to establish some financial goals. No matter what your tax bracket is, setting goals and planning results in better financial results vs. not doing so. By setting financial goals, you’ll have a better grip on where you want to go, how you plan to get there, and when you will arrive.

The more specific you are about your financial goals, the better. For example, instead of claiming that you would like to be able to afford a good college for your kids, state how much you plan to have saved in the next ten years. You can apply the same approach to any financial goal, such as having a certain amount saved for semi-retirement at a certain age so you won’t have to work full-time.

Another important part of investing is your risk/return profile. You must be aware of your risk tolerance so you don’t get spooked if and when your investments are not where you expected them to be at specific journey points. Otherwise, you are likely to make emotional decisions with your finances, which can have damaging effects.

Risk tolerance can be challenging to pinpoint. To find yours, it helps to consider how you respond to specific situations, such as how you’ve responded to past losses in the financial markets. Observe how you’ve reacted when the financial markets have experienced a downturn to gauge how much you can handle before you act and make changes.

Considering the ability of real estate to create wealth, you’ll probably want to include real estate in your wealth-building plan. Fortunately, real estate has proven to be less volatile than most other asset classes, including stocks. So, you shouldn’t have to endure the roller coaster ride that having an investment portfolio comprised solely of stocks would require.

Risk plays into real estate in various ways. For example, properties that are currently under development will carry greater risk vs. a property positioned in a prime location that’s already completed and fully leased, offering greater security.

Experts suggest that between 25% and 40% of your net worth should be tied to real estate. This range gives you the opportunity to benefit from the returns that this asset class has to offer but also leaves room for exposure to other assets. However, this ratio isn’t set and stone and can be adjusted based on conditions such as your risk tolerance.

Financing Real Estate Investments

One of the most important decisions you’ll have to make when investing in real estate for wealth building is how you will finance your investment. The type of real estate asset you pursue will influence the type of financing you are likely to secure.

Beginner investors in residential properties might buy their first home with a loan from the Federal Housing Administration (FHA), the down payment for which will vary depending on the value of the property. Considering the housing authority backs this loan, a lender can feel secure about providing the borrower with a more attractive interest rate.

If it’s a multi-family home, you can live in a part of it basically for free while collecting rent on the other floors/sides. Ideally, your rental income should surpass any mortgage or mortgage insurance so that you have some cash flow.

Of course, in real estate, cash is still king. So, if you can pay for your property upfront, this paves the way for savings thanks to the convenience factor you’re providing to the seller. Surprisingly, there are some risks associated with paying cash for real estate.

For example, by paying cash, your potential returns are more limited vs. using financing options. A Forbes article details that by investing $250,000 in a property and then turning around and renting it out for $2,000 monthly, you’ll generate gross returns of $24,000 annually, a 9.6% gross return on your investment.

However, by applying a $50,000 down payment on that same property, coupled with a mortgage at a 5% rate, you are paying less than $1,000 per month on that property. By renting it out for the same $2,000 and then deducting the mortgage payments, you have an annual gross revenue of over $12,200, resulting in a 25% gross return on your $50,000 down payment.

Another option is to finance your investment with a private lender instead of a traditional financial institution. Private lenders are known for having greater flexibility than banks regarding who they will approve and the speed at which the borrower receives the funds in their account. You might face a higher interest rate in exchange for those benefits.

You could also explore a hard-money loan, a type of bridge loan that’s dependent upon the property it’s financing. As the name suggests, a bridge loan is designed to tide an investor over until a certain milestone is reached, such as selling the property or completing repairs. It’s a good choice if you are investing in a house to flip it for a profit.

A bridge loan can also be used as a quick source of financing until the borrower can obtain a more long-term source of financing. They can be obtained in as little as a week. However, the speedy funds come at a cost because the rates on these products tend to be higher vs. a traditional mortgage loan.

In addition, there are risks associated with bridge loans. For example, if you fail to finish any necessary repairs on the property in a certain window, say six to 12 months, you’ll be left with a pricey loan for longer than you expected.

If all else fails, you can rely on traditional financing for real estate investing, such as a conventional mortgage loan from a bank. In this case, the loan terms will reflect your credit history and the lender’s confidence that you’ll be able to repay it on time.

Conclusion

Real estate is one of the most popular ways of generational wealth building, and it’s not going anywhere. If you’re looking for diversification in your investment portfolio and are willing to stick with it for the long haul, real estate has been proven to generate higher returns vs. other asset classes that lead to greater financial freedom.

You’ve got no shortage of ways to invest, whether through REITs, private funds, rental properties, or something else. And you can pursue the type of financing that best suits your situation, whether it’s a bridge loan, FHA loan, or something else. The key is matching your long-term financial goals with your real estate investment strategy and risk/return profile. And then focus on wealth-building for generations to come.