Real Estate Basics
Property as a Wealth-Building Tool
Introduction
Real estate has created more millionaires than any other asset class. Whether through homeownership or investment properties, real estate offers unique advantages: leverage, tax benefits, appreciation, and cash flow. This lesson covers the fundamentals of real estate in personal finance.
Renting vs. Buying: The Real Calculation
The decision to rent or buy is more nuanced than many people realize.
Common Myths:
- "Renting is throwing money away" - False. You're paying for shelter, flexibility, and avoiding ownership costs.
- "Buying is always better financially" - False. Depends on many factors.
True Costs of Ownership:
Monthly costs beyond the mortgage:
- Property taxes (often 1-2% of home value annually)
- Insurance
- Maintenance (budget 1% of home value annually)
- HOA fees (if applicable)
- Repairs and replacements
The 5% Rule (Rough Guideline):
If annual ownership costs (excluding principal paydown) exceed 5% of the home's value, renting may be better financially.
When Renting Makes Sense:
- You'll move within 3-5 years
- You want flexibility
- You're not ready for ownership responsibilities
- Local rent is cheap relative to buying
- Your career is volatile
When Buying Makes Sense:
- You'll stay 5+ years
- You want stability
- You can afford 20% down (avoid PMI)
- Local rent is high relative to buying
- You're ready for maintenance responsibilities
How Much House Can You Afford?
The 28/36 Rule:
- Housing costs should not exceed 28% of gross monthly income
- Total debt payments should not exceed 36% of gross monthly income
Example with $6,000/month gross income:
- Max housing payment: $1,680 (28%)
- Max total debt: $2,160 (36%)
Being "House Poor":
Many people buy at the maximum they're approved for. This is dangerous:
- Leaves no margin for other financial goals
- Creates stress if income drops
- Prevents wealth building in other assets
Conservative Approach:
Aim for 20-25% of income on housing, leaving room for saving and investing.
The True Cost of a Home
Purchase Costs:
- Down payment (ideally 20%)
- Closing costs (2-5% of purchase price)
- Home inspection
- Moving costs
- Initial repairs/improvements
Ongoing Costs:
| Cost Category | Annual Estimate |
|---|---|
| Mortgage payment | Varies |
| Property taxes | 1-2% of home value |
| Insurance | 0.3-0.5% of home value |
| Maintenance | 1% of home value |
| Utilities | Varies |
| HOA (if applicable) | Varies |
A $400,000 home might cost $10,000-15,000 annually beyond the mortgage.
Real Estate as an Investment
Beyond your primary residence, real estate can be an investment strategy.
Ways to Invest in Real Estate:
1. Rental Properties
Own property and rent it out for income.
Pros:
- Monthly cash flow
- Appreciation potential
- Tax benefits (depreciation)
- Leverage (bank funds most of purchase)
Cons:
- Active management required
- Tenant issues
- Maintenance costs
- Vacancy risk
- Significant capital required
2. Real Estate Investment Trusts (REITs)
Buy shares in companies that own real estate. Trade like stocks.
Pros:
- No management required
- High liquidity
- Low minimum investment
- Instant diversification
- Required to pay 90% of income as dividends
Cons:
- No control over properties
- Correlates with stock market somewhat
- No leverage benefits
3. Real Estate Crowdfunding
Invest in specific projects through platforms like Fundrise, RealtyMogul.
Pros:
- Lower minimums than buying property
- Access to commercial real estate
- Passive investment
Cons:
- Less liquidity
- Platform risk
- Newer, less proven
Leverage: Real Estate's Secret Weapon
Real estate allows you to control a large asset with a smaller investment.
Example:
- You buy a $300,000 property with $60,000 down (20%)
- Property appreciates 5% to $315,000
- Your $60,000 investment grew to $75,000 (25% return)
The 5% appreciation on the property translated to 25% return on your investment—this is leverage.
The Downside:
Leverage works both ways. If the property drops 10%:
- Property value: $270,000
- Your equity: $30,000 (50% loss)
Leverage magnifies both gains and losses.
Tax Benefits of Real Estate
Real estate offers unique tax advantages:
Primary Residence:
- Mortgage interest deduction (if you itemize)
- Property tax deduction (up to $10,000 SALT cap)
- Capital gains exclusion: $250,000 single, $500,000 married (if lived there 2+ years)
Rental Properties:
- Depreciation deduction (reduces taxable income)
- Operating expense deductions (repairs, management, etc.)
- 1031 exchange (defer capital gains by buying similar property)
- Potential pass-through deduction (20% of rental income)
Getting Started with Real Estate Investing
If You're a Beginner:
- Start with REITs in your investment portfolio (easy, liquid)
- Buy your primary residence when ready (forced savings, stability)
- Consider house hacking (rent out part of your home)
- Only pursue rental properties after you have:
- Solid emergency fund
- Retirement accounts on track
- Capital for down payment + reserves
- Time and willingness to manage
House Hacking:
Live in part of a multi-unit property and rent the rest:
- Buy a duplex, live in one unit, rent the other
- Rent rooms in your house
- Airbnb part of your home
This can offset or eliminate your housing costs while building equity.
Key Takeaways
- Renting vs. buying depends on your timeline, local costs, and lifestyle—neither is always better
- Use the 28/36 rule but aim lower to avoid being "house poor"
- True home costs extend far beyond the mortgage payment
- Real estate investing can happen through rentals, REITs, or crowdfunding
- Leverage amplifies both gains and losses in real estate
- Real estate offers significant tax advantages for both homeowners and investors
- Beginners should start with REITs or house hacking before pursuing full rental properties
Summary
Real estate can be a powerful wealth-building tool but isn't right for everyone or every situation. The rent vs. buy decision depends on timeline, local costs, and personal factors—not the myth that "renting is throwing money away." If buying, stay well within your means using the 28/36 rule as a maximum, not a target. Beyond homeownership, real estate investing can happen through rental properties (active, high capital), REITs (passive, liquid), or crowdfunding platforms. Leverage is real estate's unique advantage but works both ways. The significant tax benefits make real estate attractive, but beginners should start simple and only take on rental properties when truly ready.