Investing in real estate can be a relatively safe way to grow wealth. Although buying a home can cost a lot of money, real estate prices tend to rise and you could see a positive return on your investment if you maintain the property well. However, many people who buy houses have much of their net worth tied up in the home’s equity. Having too much of your net worth tied up in real estate can result in liquidity problems; it exposes you to more risk and prevents you from pursuing other investments.
Many people ask us “What percent of your net worth should be invested?” But let’s take that question a step further and ask “How much of my net worth should be in real estate?”
What percent of assets should be in real estate?
It is commonly agreed that allocating between 25 and 40 percent of your net worth to real estate ( including your home) allows you to capitalize on the advantages of real estate ownership while giving you plenty of flexibility to pursue other avenues of investment and wealth development. This percentage can vary depending on age, risk tolerance, and other factors.
It’s worth considering the type of risk in these real estate investments. Development investments are significantly riskier than full-leased, prime location rental properties. Additionally, one sector of real estate can suffer while another thrives. This is occurring right now as industrial properties rise in value while retail properties continue to fall.
By looking at the risk and concentration of real estate investments, the investor can determine whether they are comfortable being over or underweight to real estate.
Why do investors add real estate to their portfolio?
The benefits of investing in real estate are numerous. With well-chosen assets, investors can enjoy predictable cash flow, excellent returns, tax advantages, and diversification—and it's possible to leverage real estate to build wealth.
Five pros of investing in real estate investments are:
- Real estate can appreciate over time.
- Real estate can bring you tax incentives.
- Real estate can provide a mostly passive income.
- Real estate lets you use leverage and build equity.
- Real estate can allow you to have direct control over your investment.
One area that is underappreciated in real estate is the tax efficiency. Using a daycare as an example, the building can undergo a cost segregation study, allowing the investor to depreciate parts of the building at different rates. Quicker depreciation benefits the investor by allowing them to offset the income from rental payments.
Additionally, for investors invested in a partnership real estate fund, the dividend payments are typically taxed as qualified dividends, meaning they are taxed at lower tax rates. Combining this benefit with the ability to offset income with depreciation means the after-tax cash flows from real estate can be extremely attractive for business owners.
How do you calculate real estate into net worth?
The net worth formula is a rather simple one: Net Worth = Total Assets – Total Liabilities.
There are plenty of net worth calculators available online that can help you calculate your net worth. However, as a real estate investor, it’s important to know how your net worth is calculated and what information you need to collect. To find your net worth, you will first need to collect information about everything you own and everything you owe.
To simplify the calculation, divide your assets list into four categories and assign a monetary value to each:
- Tangible assets: These are items of value that have physical properties. This is where real estate factors into your net worth and also includes things like furniture, cars, collectibles, and more.
- Equity assets: These are your ownership in businesses, including stocks, investments in partnerships, retirement accounts, life insurance cash value, etc.
- Cash and cash equivalents: These refer to cash you own and other short-term highly liquid investments, such as money market accounts, checking accounts, savings accounts, etc.
- Fixed income: These are long-term investments that pay a fixed amount of interest on a fixed schedule, such as bonds.
Add the numbers you get from these categories for your total assets. The next step is to calculate your liabilities, everything you owe. These can be divided into two categories:
- Secured debts: These include car loans, home equity loans, mortgages, etc.
- Unsecured debts: These included credit card debt, student loans, personal loans, taxes that are due, medical bills, etc.
Add the numbers you get from these categories to get your total liabilities. Finally, apply the net worth formula to calculate your total net worth.
Real Estate Investing in Indianapolis
At Delta Wealth Advisors, we’re proud to support our clients in all aspects of sound, unbiased financial planning and wealth management. If you are trying to get into real estate investing, we’d love to talk with you and share our decades of experience and insight. Let’s get you started on the right foot. Contact Delta Wealth Advisors today to start a conversation.
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