The Real Estate Asset Class

The Real Estate Asset Class

I am convinced that we look at real estate wrong. Or maybe not wrong, but only view it as a mechanism to retire early. While true, rent collection can be a very strong provider of passive income, there are several other ways in which one benefits from the real estate asset class. I prefer a smaller pockets type allocation. Less doors. Less hassles. And yet countless benefits.

Often those who try to integrate this valuable investment into their portfolio and fail have made one simple mistake. They have aimed too high and moved too fast. My why of of real estate is much more defined and less audacious.

Diversification

I love the stock market. On the relative passivity scale, you can’t beat index investing. Why work for your money when you can sit back and watch returns come in? Sounds great! Unfortunately holding simple paper assets while diversified in class, provides lousy over all risk management for market downturns.

One can’t invest in stock alone.

The real estate asset class is uncorrelated from the stock market. Often one zooms upward or downward while the other is unaffected. This is key for proper diversification.

I like to hedge my bets. Even if the returns are not always as high as classic index investing.

Tax Efficiency

We are big fans of tax deferral. The first thing we do is max out our 401Ks and IRAs. This makes sense. Why not let your money grow tax free? There is a slight problem though. There are only so many tax deferred options available. After that, we have to make a decision.

The real estate asset class is an elegant answer. Although after tax money is most often used to fund the investment, it is allowed to grow in a tax deferred manner. Any growth in equity due to appreciation will not be subject to Uncle Sam until the property is sold.

And if really tax adverse, even after the sale, a 1031 exchange can be arranged to further postpone being taxed on any profits. This is extremely handy for those living off the cash flow of rental properties. Wise investing in an inefficient market can lead to the ever growing real estate empire without ever paying a cent of taxes. Buying low and selling high is the name of the game.

Another great advantage is depreciation. Although most properties increase in value over time, the governmental allows us to take depreciation in a scheduled manner. This is especially handy if a rental property cash flows.

Although my rental properties cash flow to the tune of 50K a year, I can defer tax by taking depreciation on each property. This is only deferred and will have to be paid upon sale of the property unless a 1031 exchange is arranged.

Cash Flow

For me, in many ways, the real estate asset class is like a glorified dividend stock. Each month I collect rents and pay expenses. What’s left over is my dividend. Unlike the stock market, however, I can balance my profits with depreciation and thus delay my tax burden.

Yes, there is more work involved than a passive index fund. But, I get a mostly uncorrelated investment with tax benefits for all my hard work.

Not a bad tradeoff in the end.

Final thoughts

I have no interest in being a real estate mogul. I don’t want to own tons of doors nor deal with the headaches that come with it. The real estate asset class is not my full time job. Instead, I would like a handy tool that allows diversification, tax efficiency, and a modicum of cash flow.

Owning four rental condos has done this for me in spades. It has fulfilled all my needs.

For the moment, at least, I’m not really looking to pick up more.