Real estate is a popular investment for many people. However, it’s important to recognize that investing as an owner is different than investing as a lender. Furthermore, the investment changes depending on whether you are a majority or minority owner. The type of investment that you make depends on your financial goals and investment mindset. This post looks at the liquidity, safety, expenses, rate of return, and tax efficiency of real estate investments.
Liquidity might be a problem for minority owners since they can’t control when the property is sold or refinanced. For example, if you invest your money in a property and expect it to be sold quickly, but it doesn’t sell quickly, then you will have trouble accessing your money. Liquidity can be better for majority owners since they decide when to sell and access their cash. Lenders are similar to minority owners in terms of liquidity. A lender can’t force an owner to sell the property when he or she needs cash.
Minority owners have the least amount of safety since they have the least amount of control. They can lose money if the property is mismanaged. Since Majority owners have more control they have more safety than minority owners. On average real estate has proven to be a safe investment over time for majority owners. Compared to minority and majority ownership, real estate lending may be the safest investment. Lenders control the amount of risk they are willing to take based on the required down payment. When lenders want to assume less risk, they can increase the amount of the down payment that they require.
Due to the expenses associated with real estate, it is generally considered a long-term asset. One exception may be when a property is purchased at a discount so that it can be flipped to make a profit despite the expenses. Minority and majority owners face more expenses than lenders. The former group has purchase expenses, management expenses, and disposition expenses which are associated with selling the property. Lenders don’t face these expenses. They just lend the money to the people buying real estate—the people who face all of the expenses.
Rate of Return
The rate of return tends to be high for both majority and minority owners. Over time both groups may even see double digit returns. In general, the rate of return that lenders see depends on the size of the property. Lending to someone who purchases a single family home is different than lending to someone who purchases a large commercial real estate project, and the rates of return can vary greatly.
Real estate owners face a better tax situation than real estate lenders. Depreciation gives owners the ability to shift their tax burden to the future. When it’s time to pay the depreciation recapture tax, owners can usually pay the tax with the proceeds from selling the property. Still, the capital gains tax rate that owners pay is better than paying ordinary income tax rates. Lenders, though, have to pay ordinary income taxes on their gains, so their tax situation is not as favorable as owners.