Real estate has had a unique past five years. Significant fluctuations in the sector from interest rates, supply chain and labor issues, and pandemic-era trends have impacted both the commercial and residential markets. So, while real estate has essentially always been a stable long-term investment, in the short term, changes can be dramatic. That’s why it’s important for those considering a real estate investment for the first time to do their research before locking up their money.
Smart Business spoke with Logan Siebert, a Supervisor in the Tax Department at Corrigan Krause, about the state of real estate investing and what those looking to invest in the sector should know before doing so.
What are some real estate investing options?
There are levels of real estate investment. Someone could earn a return renting a cabin or they could be investing with a group, pulling funds together to buy an apartment building. An individual could own all of a property — the least complicated structure — but it means the individual has to bring all of the needed knowledge and capabilities to the table. More often real estate investment is done with a group. That could mean investing with known partners or crowdfunding investors from across the country or the globe.
For new investors, where to start depends on what kind of investor they want to be, as well as the level of involvement they’re capable of contributing. For someone who is just looking to stick some money away and have the least amount of involvement, the primary metric is the rate of return. A good place to start when that’s the situation is a real estate investment trust (REIT). A REIT is a larger partnership that’s essentially just looking for capital. However, they can be very complicated, so it’s advisable to work with a real estate investor and bring capital to the table to be a part of a privately held partnership.
Those who want to have a more hands-on role in the investment should do some work before investing to prepare. That could include looking at market analysis, property valuation, financing options, and getting an understanding of how rental property management works. Rental property management is a key area that often gets overlooked by first-time investors as there are a lot of potential risks with property ownership — vacancies, maintenance costs, market fluctuations, etc. If a property is not managed properly, occupancy will be low and money-wasting exposures can pop up, draining money away from the returns.
What are the tax implications?
Real estate investments are passive for most investors. From a tax point of view, passive losses from investing cannot be offset with active income, such as from a business the investor has material participation in or from their salary. However, often in the initial years, new investors will see a loss because of accelerated depreciation on the property. Having flow-through losses isn’t really an issue. But if the investor can’t utilize them, they’re not useful. So, it’s important to understand the tax implications, the classifications of income and deductions, and how that affects the investor on an individual level before investing.
Where should a new investor begin?
Introducing real estate into an investment portfolio can add diversity and reduce volatility as it has a low correlation with traditional assets such as stocks and bonds. Still, allocation of real estate should align with the investor’s risk tolerance, investment objectives and time horizon. It can be the case that a new investor won’t see the real cash flow from a larger investment for years down the road. So, before investing, get educated. Understand performance trends, investment options and other considerations. Recognize that real estate is often a cash-heavy investment, so it’s important for the investor to know their financing options, as being too leveraged isn’t ideal.
Investors should consult with their professional advisers, including their CPA, before making any major real estate decisions. Everyone’s tax implications are different based on their activity, which isn’t isolated to their real estate investments. And what works for one person may not work for another. CPAs understand the broad scope of the opportunities and can help guide investors.
