Understanding the basics of real estate can help a buyer or seller stay one step ahead of the competition in today’s competitive marketplace. From buying a home to live in to purchasing a property to rent out, owning real estate can be a key way to build net worth, save money on taxes, and even generate a little extra income on the side.
Key takeaways
- The main reasons for owning real estate are appreciation in property value, taking advantage of lower interest rates to own a “real” asset, hedge against inflation, and generate extra income.
- The four types of real estate classes are residential, commercial, industrial, and land.
- Tax benefits of owning real estate include deducting mortgage interest, property taxes, and excluding up to $500,000 from capital gains tax when a primary residence is sold.
Why people own real estate
People purchase real estate for a variety of reasons, including the opportunity to build wealth over the long term, generate some extra monthly cash flow, and hedge against the risk of rising inflation.
Appreciation in property value
Real estate prices historically increase in value over the long term. Simply by taking care of the home and paying property taxes and insurance, a homeowner may be able to increase their net worth. According to Zillow (Sept. 30, 2021), the typical value of a middle price tier home has increased by about 93% since November 2011, with home prices forecasted to grow by another 13.6% over the next year.
Potential for monthly income
People don’t need to be professional real estate investors to generate a little extra income from a rental property. Some common ways to make money from real estate include renting out an extra bedroom, turning a basement or attic into a studio apartment, or using part of a garage as rentable storage space.
Leverage low interest rates
Although mortgage interest rates are gradually rising, they are still at historic lows. As Freddie Mac reported, as of November 10, 2021, a 30-year fixed rate mortgage currently has an interest rate of 2.98% and a 15-year fixed rate mortgage offers an interest rate of 2.27%. For borrowers with a good credit score and debt-to-income ratio, down payments to finance the purchase of a primary residence are as low as 3.5% with an FHA loan and 0% down for eligible VA loan borrowers.
Potential Inflation hedge
People also own real estate to potentially hedge against inflation. As construction costs rise due to higher wages and supply costs, builders pass the higher cost of building a home through to the buyer. In turn, this causes both new home prices and the price of resale homes to rise. By purchasing real estate, investors are able to lock in the price of property in today’s dollars–avoiding the impact of future inflation and price increases.
4 different types of real estate
The first thing most people think about when they hear the words “real estate” is residential property like a single family home, townhouse, condo, or apartment. However, there are actually four main types of real estate classes:
- Residential real estate includes single family homes, condominiums and townhomes, mobile homes, and small multifamily properties with 2-4 units.
- Commercial real estate includes property used for businesses, such as retail shopping centers, office buildings, large apartment buildings, and mixed-use properties that have a combination of residential and commercial space.
- Industrial real estate includes storage and distribution centers, refrigerator and freezer facilities, laboratories and R&D properties, warehouses, and factories.
- Land includes undeveloped or raw land, land used for mining, farming or ranching, home subdivisions with lots, and even the individual lots themselves.
Tax benefits of real estate
Many people are surprised to learn that the tax laws in the U.S. are friendly to people who own real estate. Tax benefits are one of the reasons why many people invest in real estate.
Here are some of the main tax benefits of homeownership, according to the Tax Policy Center:
Mortgage interest deduction
Homeowners can deduct the interest paid on up to $750,000 of mortgage debt incurred after December 14, 2017 to buy or improve a primary or secondary residence, such as a vacation home.
Property tax deduction
Provided a tax return is itemized, a homeowner may deduct the property taxes paid on a home, up to a maximum of $10,000 in state and local taxes.
Capital gains tax exclusion
Profits or capital gains from a home sale are tax free, up to a limit of $250,000 for individuals or $500,000 for joint filers. As a rule of thumb, a taxpayer must have lived in the home as a primary residence for 2 of the previous 5 years, and not claimed any other capital gains tax exclusion from the sale of a primary residence during the 2 previous years.
How to invest in real estate
People purchase real estate for two main reasons.
The first is buying a home as a primary residence to live in, rather than to rent out and generate rental income. Common ways to find a home for sale to live in include:
- A real estate agent with access to the local MLS.
- Online listing platforms like Zillow and Realtor.com.
- Word-of-mouth by speaking to family or friends to find an off market listing.
The second reason people purchase real estate is as an investment, with the hope of generating recurring income and profit over the long term. Some of the ways to invest in real estate include:
- Buying shares of a private or publicly traded real estate investment trust (REIT).
- Investing money in a crowdfund to own part of a large project, such as a new home development or retail shopping center.
- Purchasing an investment property listed for sale on the Roofstock Marketplace.
Important real estate terms to know
Real estate uses unique abbreviations, words, and phrases that can make a homebuyer feel like they are learning a new language. Realtor.com publishes a first-time home buyers’ guide with dozens of different real estate terms.
Here are 16 of the most common real estate terms to know:
- Listing is a property being marketed for sale on platforms such as the local MLS, Zillow, or Roofstock.
- Listing agent is a licensed real estate agent representing the seller of a property.
- Buyer’s agent is a licensed real estate agent representing the buyer of a property.
- Pre-qualified is an estimate of the amount of money a buyer can borrow.
- Pre-approval letter is a written statement from a lender stating the amount of money that can actually be borrowed.
- Fixed rate mortgage has a fixed interest rate of the term of the loan, which is generally 30 years or 15 years.
- Adjustable rate mortgage is a loan where the interest rate is periodically adjusted over the term of the loan .
- Offer is a written proposal to purchase a property based on specific terms and conditions, such as the purchase price and the closing date.
- Counter offer is a seller’s response to a buyer’s offer, with some real estate negotiations going through multiple counter offers back and forth between a buyer and a seller.
- Contract is a written purchase and sale agreement drawn up once a buyer and seller have completed the offer/counteroffer process and reached a “meeting of the minds.”
- Credit is typically used to describe a sum of money given to the buyer by the seller, such as a credit of up to $5,000 for buyer closing costs.
- Home inspection is generally conducted by a professional home inspector to verify the condition of the property after the contract has been accepted.
- Appraisal is normally ordered by a lender to verify that the market value of the property is equal to or greater than the purchase price a buyer and seller agree to.
- Contingencies are conditions that must be met in order for the transaction to close, such as an appraisal contingency and a financing contingency stating that a buyer can get a loan.
- Title insurance protects a lender and buyer from undiscovered claims on the property, such as an unpaid contractor or tax lien.
- Closing costs include items such as title and escrow fees, loan costs, prepaid property taxes and insurance, and the real estate commission (normally paid by a seller).
Wrapping up
Owning real estate offers a number of potential advantages. People buying a home as a primary residence may see the property value rise over the long term, and be able to claim tax benefits such as a property tax deduction and capital gains tax exclusion.
Real estate also offers the opportunity to generate additional monthly income, by renting out an extra bedroom, garage space, or even an entire house. Regardless of why someone is purchasing real estate, buyers take the time to do research and conduct due diligence before buying a property.
