Real estate investments can be direct or indirect. The owner of a direct investment holds legal title to the property he or she has purchased. Direct real estate investments include single-family house, duplexes, apartment buildings, land, and commercial property.
A Home as an Investment
What is a home? Obviously, it is the place where you and your family live. However, owning a home can also be a good investment.
According to Mortgage Bankers Association of America, home ownership is most Americans’ largest financial asset. In 2003, the market value of homes in the United States was nearly $12 trillion, which was 50 percent higher than five years earlier. Homeowners’ equity, the value of a home less the amount owed on the money borrowed to purchase it, accounted for 30 percent of household wealth.
During periods of inflation, the purchasing power of your money declines. Investing your money can help you stay ahead of inflation. Owning a home is a good investment because, generally, home prices have risen steadily over the years. In fact, during the past 150 years, owning a home produced an average rate of return after inflation of about 2.5 percent. That is about the same rate of return you would expect from a bond.
Most homeowners have mortgages, which can provide certain tax benefits. Homeowners can report the interest charges on mortgage payments as well as property taxes as deductions on their income tax returns.
Vacation Homes Investment
Second-home mortgages also provide tax benefits as direct real estate investments. For example, Kevin’s parents own a vacation home on Fox Lake. It is a good investment because the family uses it year-round and never rents it out to others. According to the federal government, that qualifies it as a second home. Therefore, Kevin’s parents can take advantage of certain tax deductions. If the parents rented out the home for more than 14 days each year, the government would consider it a rental property. As a result, any tax deductions would depend on whether Kevin’s parents managed the property and on the size of their income.
Commercial Property Investment
In addition to the vacation home on the lake, Kevin’s parents also investing in commercial property investment. Commercial property investment is land and buildings that produce rental income. Kevin’s parents own an apartment building that adds to their income. Other examples of commercial property investment include duplexes, hotels, office buildings, and stores. Most small investors favor duplexes, four-plexes, or small apartment buildings. Many investors start investing in commercial property by purchasing a small commercial property. Then they buy larger properties as the equity in their original investment increases.
Land Investment
In 1986, Kevin’s parents received quite a shock. Tax laws in the United States were rewritten so that many popular real estate investments, such as apartment buildings, lost some of their tax advantages. Owning commercial property investment became less appealing to some real estate investors. Many of these investors began investing in land that was ready to be developed.
Kevin’s parents talked to an investment banker before they purchased land. She told them that while land investments often promise tremendous gains, they also pose enormous risks. If construction in general slowed or business activity declined, Kevin’s parents might not be able to sell their property at a profit. Even worse, they might not be able to get the price that they had paid for it. Furthermore, the banker reminded them that unlike an apartment building, land in urban areas usually does not produce any income.
The banker also cautioned Kevin’s parents about buying land and then dividing it into smaller lots to build single-family house. They must be certain that water, sewers, and other utilities would be available. Otherwise, they would have to supply those services. The most common and least expensive way to obtain water and sewer ser- vice is to connect to existing services in a nearby city or town.
