What Real Estate Is
Real estate involves the rights to real property, which is distinguished from personal property by way of real property involving land ownership. Personal property is property that is movable, where real property is immovable, or at least affixed to the ground in such a way that it would be very difficult to move.
So one’s house and the land on it would be real estate, since the land is immovable, and the house might be able to be moved, if it were on a concrete slab for instance and were jacked up, but the fact that it is not readily moved would qualify it for inclusion in the real “estate.”
When one thinks of real estate, this is thought to involve the buying and selling of houses, but real estate includes any property with land, including parcels of land itself, commercial real estate, and industrial real estate.
Given the fact that real estate tends to appreciate in value, it is always an investment of sorts, and long term it is one of the best investments you can make. When you add in the utility of people owning their own residence, and a lot of people do own their own homes, this is an investment that provides more benefits than just capital appreciation.
The Appreciation of Real Estate
So why does real estate tend to go up in value over time? Well it’s not the structures, as these structures do depreciate naturally like just about everything else. The easiest way to think of this is the cost over the years of repairs and renovations to keep your home up. If you did not do this, then the place would just go downhill and the structures itself would be worth less to people.
Eventually, if you did not maintain the property, it may even get to the state where it may be condemned and need to be torn down, as worthless.
The reason why a home or other real estate tends to be worth more over time is due to land values increasing. There is only so much land in a given area, and its supply does not ever increase. However the demand for it does tend to increase, as the population base goes up, and if supply does not go up and demand does, price will go up.
As cities see their population grow, the real estate market in the city grows in turn, and while it may expand outward, this is going to cause all the land in the area to go up in value, just from that growth. Even the people who are renting put upward pressure on real estate values, as the expansion of the market for rental properties puts upward pressure on prices.
The better located an area is, the more it is in demand, and this is why real estate agents emphasize location so much. It’s not just about that though, as even the fringe areas will see the benefit of higher property values as the city expands and these areas become more desirable.
Things like population growth overall will keep this trend going, as this is not just a matter of the demand for one area going up at the expense of another. There’s only so much private land in the world and the more people that compete for this, the more valuable it is going to be over the long run.
Buying Your Own Home
Since we do have to live somewhere, the basic choice that we are faced with is whether we are going to seek to own our own residence or rent it. Owning does involve taking on financial responsibilities, for instance with the mortgage payments, the property taxes, and the upkeep of the property.
Since residences are very expensive, few people have the cash to lay out to buy one, and therefore must borrow. So they do need the means to both get approved for a mortgage and the means to maintain the obligation, and not everyone does.
This requires a reliable source of income, an acceptable credit history, and usually a down payment. Not having all of these things can be a barrier to home ownership, and while one may seek out a subprime lender, with lower standards and higher interest rates to match, these arrangements can be even more difficult to maintain due to their higher costs, and must be approached with caution.
When This All Goes Wrong
The worldwide recession of 2008, the worst recession the world had seen since the Great Depression, was caused by a collapse in the subprime mortgage market. Many were given a mortgage without the adequate means to maintain it, and once the defaults started to mount, the whole thing collapsed like a house of cards.
This happened primarily because the real estate market was artificially bloated due to the increased demand from a lot of people who never should have qualified for a mortgage, and the mortgages themselves were structured such that prices would have to continue upward to keep the deals together.
So the payments were set artificially low for the initial term, so that the property owners could afford them, although they often could not afford payments based upon the current market, so the plan was to refinance the deals based upon an anticipated higher value, and use the equity to manage the principal.
So when the real estate market started to correct, this appreciation was not there, and as these deals came to term and the true amount of the payments needed to be used. A lot of people couldn’t afford the new payments, because they couldn’t afford them in the first place, and this led to a lot of foreclosures and a lot of supply hitting the market, which depressed prices.
One’s Residence as a Sound Investment
So provided one does have the means to successfully own one’s own home, to meet the financial obligations involved, home ownership tends to be a fabulous investment, especially over renting.
People who rent think that the biggest issue with renting is paying off someone else’s mortgage when they could be paying down their own, but there’s another big way the owner of the property benefits here, from accruing wealth from the increasing value of the property.
Let’s say you rent a property for 25 years and it was worth $100,000 at the time you moved in, and your rent payments pay off the mortgage on this property for the same amount, held by the owner.
After the 25 years have elapsed, let’s say the property is now worth a lot more than just the $100,000, it may be worth $300,000, not an unreasonable increase over this much time, and the owner now owns it free and clear. So they have benefited by your paying off their $100,000 mortgage for them, and by their owning it and not you, they have also made an additional $200,000 on the deal.
You then move out, and instead of walking away with $300,000 in wealth, you walk away with nothing, and perhaps even have to beg the landlord to return the small damage deposit you put on the rental all those years ago.
Real Estate Investments Provide Many Benefits
So owning your own home is a pretty big deal indeed when it comes to building personal wealth. This can mean the difference between having a nice nest egg in retirement, or living in squalor on a pension. In our scenario, the couple who rented had to move out due to having since retired, and were no longer able to afford the rent, and due to the reduction in their income could only afford a cheaper place.
The couple who bought sold their property, took the proceeds and downsized into a condo since they didn’t need all that space anymore, pocketed half the proceeds, or $150,000, which they have now invested to make their retirement years more comfortable.
They still own their property and will continue to see benefits from that into their golden years and perhaps even leave a nice sum of money to their family when they pass. The renting couple are just getting by, they are broke all the time, and they still have to deal with ever increasing rent payments with their small, fixed incomes.
Another benefit that many do not consider is the fact that when you buy a residence, the payments on it are based upon the original size of the mortgage, and neglecting changes in interest rates, the payments on it get smaller and smaller in effect.
This is due to inflation, and for instance if your mortgage payment was $1500 a month today, people’s incomes rise over time due to inflation, but this payment does not. So let’s say this was 30% of your income now, it will represent a smaller and smaller percentage of your income over time, as your income increases.
When you rent though, rent payments do go up as income goes up, with inflation, so you are lucky to maintain the percentage of your income spent on this, and if your income drops, like in our scenario, you might not even be able to manage this anymore.
So owning your own home is a fabulous idea for many reasons, and along the way you can even use the equity you have built up in it to get better interest rates on your other debts, allowing you to pay them down faster and become debt free easier.
There are other ways to invest in real estate, you could buy rental properties yourself, you could buy land in order to speculate on it, you could buy commercial properties and lease them, you could even invest in a real estate investment trust or REIT, which owns and manages real estate.
Real estate is a solid investment overall, especially if you get to be the king and queen of your own castle as an additional benefit, and build wealth all along the way.