Continuing from my previous blog, today I would like to explain why I prefer real estate investment.
The first compelling reason lies in the substantial advantage of leveraging when acquiring real estate. In contrast to buying stocks or gold, where you typically need to pay the entire purchase amount upfront (with the exception of using margin accounts for stocks, which still require an initial cash outlay for the purchased stocks), real estate transactions often involve a 20-25% down payment, with the remainder secured through a mortgage loan from a bank. This allows you to invest in real estate with an asset value that is considerably more substantial than your available cash, a phenomenon known as the leverage effect.
For instance, consider purchasing a $500,000 home. If you have $100,000 in cash and secure a $400,000 mortgage loan, the mortgage is typically repaid over 25 years. While you do incur interest costs on the mortgage balance, paying it off gradually with borrowed funds has its advantages. While many perceive the entire mortgage interest amount as an expense, in reality, it’s the difference between the mortgage interest rate and inflation. To illustrate, if the mortgage interest rate is 3% and inflation stands at 2.25%, the actual interest cost is only 0.75% (3% – 2.25%).
The second compelling reason pertains to the benefits arising from the evolving value of money. In the example mentioned above, the future value of $400,000 after 5, 10, or 25 years diminishes significantly compared to its present worth. In essence, $400,000 in the future holds much less purchasing power than the $400,000 today. Conversely, asset values tend to appreciate due to inflation. Suppose, for instance, you borrowed $400,000 twenty years ago to purchase a $500,000 home. In most cases, the property’s value has increased to at least $2,000,000. With an initial investment of $100,000, this translates into a profit of approximately 15 times ($2,000,000 – $500,000 = $1,500,000). While achieving high returns in stocks is possible, the likelihood of individuals attaining such substantial gains is considerably lower in comparison to real estate investment.
Thirdly, when you buy a home and reside in it, the income generated from selling the property is typically exempt from taxes, especially if you have owned it for an extended period (in Vancouver, long-term owned homes often see substantial gains).
Lastly, in Metro Vancouver, the housing shortage contributes to annual rent increases that outpace inflation rates. If you acquire a property and lease it out, the rental income can offset a significant portion of homeownership costs. Rent escalates annually, and while inflation boosts asset values, the mortgage loan remains at the value set during the real estate purchase (the past). This creates a mutually beneficial scenario.