Your Wealth Building Journey
If your goal is building wealth, you’ll inevitably look for inspiration — and tactics — from the wealthy. Well, there’s no better starting point than the richest class of people in the world. Ultra-high-net-worth individuals, or UHNWIs, are individuals with at least $30 million in investable assets. We’ll spare you the obvious characteristics (generational wealth, avoiding credit card debt, paying off student loan debt, etc) to give a more actionable means to start investing. One omnipresent component of wealth for these individuals is real estate. Let’s take a look at how you can copy the real estate formula from the UHNWI playbook to generate your own wealth.
Real Estate: A Staple of the High-Wealth Diet
The portfolio of UHNWIs is surprisingly textbook. The assets of the uber wealthy almost always break down into three or four primary categories.
According to the Wealth-X 2021 report, the four asset classes for UHNWIs are liquidity, private holdings, public holdings, and real estate. WallStreetMojo combines private and public holdings into a single column, thereby totaling three classes of UHNWI wealth: liquid assets, securities, and real estate.
The largest asset in the portfolio of the rich… is money. But while this is the most straightforward component of building wealth, it is also the most difficult for normal folks to copy. Presumably anyone reading this is already actively trying to accumulate cash and generate income as part of their wealth building strategy! (And hopefully with enough sense to avoid high interest debt or depleting their emergency fund in order to merely maintain a full wallet).
The next biggest class is securities (both private and public). Tradable instruments like stock and equity are incredibly worthwhile investments, but again provide a less-actionable path for the non rich. You need money to acquire these assets and time to let them mature. Not to diminish the insight that goes into that acquisition process, but securities, mutual funds, and the greater stock market are often a “set it and forget it” play.
The final class is where non-rich individuals can actively work to change that label! While real estate does require some initial capital, there’s plenty of wiggle room for prudent and industrious folks. Here’s why real estate can help you build wealth and fast track you to your financial goals.
How Real Estate Works for You
We believe real estate is one of the best ways to create wealth because it provides four channels of wealth building:
- Appreciation
- Tax Benefits
- Equity
- Cash Flow
APPRECIATION
One way real estate will build wealth is through appreciation, which is the increase in a property’s value over time. For example, if a property is purchased for $500,000 and its value increases to $600,000 over the course of a few years, the owner has generated $100,000 in wealth through appreciation.
Looking at the historical values of homes in the United States, the benefit of appreciation is undeniable.
TAX BENEFITS
Another way real estate generates wealth is through tax benefits. Property owners can depreciate assets over the useful life of 27.5 years, effectively making their taxes on active income become zero. (There are also options for accelerated depreciation over a shorter timeline). Additionally, the interest paid on a mortgage for a primary residence is typically tax-deductible, which can further reduce a property owner’s tax burden. Lastly, if you live in the property for two years and then sell it, there is a $250,000 (single) or $500,00 (married) capital gains benefit. A 1031 exchange may also be enacted to defer these taxes down the road. While much has been publicized about tax sheltering retirement savings in a 401 k, many folks never realize that shrewd real estate accounting can help more money stay in your pocket than years of office labor!
EQUITY
Equity is another source of wealth generated by real estate. Equity means the difference between the property’s actual value and the balance owed on the mortgage. As the property owner makes payments on the mortgage, their equity increases. (They own a greater percentage of the home, and the bank issuing the loan owns less). Important to note, if a property is purchased below its market value, the owner immediately has equity built into the property. Finding distressed properties that you can fix up with simple, low-cost repairs will dramatically increase the current value of the home. One of the true beauties of real estate as an asset class is on day one you can see an immediate equity jump — something you can’t do with a diversified stock portfolio.
CASH FLOW
Finally, property can prove to be a direct tool of wealth creation from rental cash flow. If a property is rented out, the owner can generate a regular income from the rent paid by tenants. This income can be used to offset the costs of owning the property, such as the mortgage, property taxes, and maintenance costs. A smart homeowner is always checking the local rental market to see if they stand to benefit from renting out their property. You don't even need to run your own business -- renting out a spare room, or building an ADU for rental purposes can boost your real estate cash flow.
Conclusion
Real estate remains the asset holding of ultra-high-net-worth individuals most applicable to the average person. To generate wealth through real estate, it’s important to find properties that are below market value, can be easily improved, can be held for the long term, and have the possibility of generating passive income. By following these rules, property owners can maximize the wealth-generating potential of their real estate investments, and perhaps one day join the ranks of the ultra wealthy.
Do you think there are better ways to create wealth than real estate? Interested to see how other people achieve their financial goals? Share this with your friends or your certified financial planner and see what they say.
