In today’s world, there are a ton of different investment opportunities. Every year it seems as though a new investment opportunity appears out of nowhere promising sky-high returns.
But even after all the innovative ways to earn a return, I truly believe that for most people, cash-flowing real estate should be their first investment. I’ve shared how, after hauling ass to earn my first $100k, I invested every penny into cash-flowing triplex.
Now let’s take a look at why cash-flowing real estate makes the optimal first investment.
Passive cash flow
For most people that are looking to make their first investment, chances are they still rely on a salary as a primary source of income. Therefore, your first investing goal should be to invest your way out of salary reliance. Relying on a salary comes with the high demands of a job/career that consume all your time. That time could be best spent searching, analyzing, and executing on more investment opportunities. The goal is to achieve financial freedom, best defined as having enough investment cash flow to cover your living expenses.
Real estate can offer great cashflow in the form of rental income. The income is consistent and fairly passive. I say “fairly passive” because it will require a bit of work until you’re able to hire a property manager. But earning rental income is nowhere near as labour intensive as earning employment income. As well, real estate cash flows give you access to leverage (discussed later), as they help service debt.
The key ingredient here is passive cash flow. Many investments can yield a high rate of annual returns, but if part of those returns isn’t in the form of cash flow, you won’t be able to pay your bills.
The power of compound returns over a long period of time can be truly amazing. Any major investment you make, especially your first investment, should have the ability to compound over time. The longer you own an asset that compounds in value, the larger your portfolio grows. Long-term compounding is also incredibly advantageous from a tax perspective.
This is why it’s so important to own real estate as early as possible and hold onto it for as long as possible. Real estate prices appreciate over the long run in a compounding manner. The compounding annual returns on real estate may only be in the low to mid-single digits, but over a long period of time, it makes a huge difference. Many investments may be able to provide you some cash flow, but the asset value likely won’t compound over time as real estate does.
Access to leverage
Borrowing to invest amplifies your returns and helps you compound faster, and at a larger scale. This is especially important for your first investment, as you are starting from zero and need to jumpstart your compounding. Leverage will also get you access to larger cash flows.
Real estate is an asset class where average investors have ample access to leverage. If you live in a developed nation, banks are more than willing to loan you a large amount of money to purchase real estate. You can acquire a piece of real estate that is 5x larger than the equity you put into it, which means more cash flows and larger compounded returns. There is no other asset class like real estate, where you’re able to get long-term loans to buy with fixed interest rates and payment terms.
Bonus: taxes & control
These two components aren’t necessary but it’s an added bonus to investing in real estate. Real estate has scalable tax benefits, such as depreciation and refinancing. You are able to earn positive cash flow and pull out your capital gains without paying any taxes. This will allow you to reinvestment more cash into other opportunities and compound even further.
Another added benefit of real estate ownership is the control you have. You can influence the value of real estate (to a certain extent) by maintaining, managing, repositioning, and renovating the property. There aren’t many investment assets that give you this degree of control to influence the price.
Why don’t most people do it then?
Many of these points seem fairly obvious, so you might be wondering why cash-flowing real estate isn’t automatically the go-to first investment for everyone.
The wrong type of real estate
Most people do in fact make real estate one of their first major purchases. The problem is, that real estate “investment” is usually their principal residence. Conventional wisdom teaches people that it’s bad to rent and that you should purchase a home as soon as possible. In the words of Robert Kiyosaki, “your house isn’t an asset”. It has 2 of the 3 necessary features above (leverage and compound returns). But it doesn’t produce cash-flow. In fact, it does the opposite – it consumes cash. For this reason, a home that you are going to live in makes for a sub-optimal first investment.
Investing for absolute returns
People often invest in stocks instead as, over the long run, they end up delivering higher returns overall compared to real estate. It’s true that, historically, stocks offer more growth than real estate as an asset class. However, this often leaves out the fact that real estate is often leveraged, which increases returns.
As well, most stocks don’t have the passive income component that’s super crucial for achieving financial independence. Once you are no longer salary-dependant, you can start investing in high growth, better absolute-return opportunities like stocks.
Another reason people avoid purchasing investment real estate is the belief that it’s more work than purchasing stocks or bonds. The thought of having to deal with tenants, brokers, and getting a bit of dirt under the fingernails turns people off of real estate.
As I mentioned earlier, the labour involved in managing real estate is nowhere near a full-time job. It’s also quite easy to hire/delegate real estate tasks. A quick Google search will give you access to contractors, technicians, and even property managers that will handle everything for you. In the beginning, you may want to do most of the tasks yourself, as you need that income to pay bills. But as you advance in your career, your time will become more valuable. At this point, you should sacrifice rental profits and hire professionals, as it will be a better use of your time.
For some, real estate is seen as a risky asset class. Maybe the 2008 housing collapse is still fresh in people’s memory, or maybe it’s the amount of debt involved. But there are many ways to mitigate risks in real estate investing such as:
- Holding long-term – even if you bought at the peak of 2008, if you held on to that asset till today, you would likely be up by a large margin
- Cash-flow positive -ensure the rent payments are more than enough to cover expenses and debt service
- Insurance – get the right type of insurance to protect you from things like fires, floods, and other unforeseen events
- Maintenance – take care of your property, and your property will take care of you (financially)
All types of investments have inherent risks, and real estate is no different. However with real estate, there are plenty of tools to help mitigate and manage risks.
Your first investment should tick these 3 boxes: passive cash flows, compound returns, and leverage. I can’t think of a better investment than private cash-flowing real estate that fits the bill.
Real estate is a proven asset class that has a tenured history of building wealth for generations of families.
Hi there! I’m Jay Vasantharajah, Toronto-based entrepreneur and investor.
This is my personal blog where I share my experiences building businesses, making investments, managing personal finances, and traveling the world.
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