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Keystone Global Partners

Keystone Global Partners

Forward-Thinking Wealth Management For Tech Founder

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Real Estate as an Investment Asset

Tech Founder’s Guide to Real Estate

Part 4: Real Estate as an Investment Asset

This article was originally published on FORBES.COM on March 12, 2021. Written by Peyton Carr.

For many people, real estate has been the best investment in their lives. However, stocks have actually been far better at generating long-term returns for investors. Why is there such a disconnect?

Misconceptions on Real Estate Returns

Peeling back the layers reveals some of the key factors that make real estate seem like the better investment:

  1. Immense use of leverage – No other common investments will allow an investor to take on the same level of debt to make an investment. Mortgages allow 4:1 leverage with a 20% down payment and even far higher levels of leverage when using smaller down payments. The leverage magnifies even small gains in the property value, but remember, it can cut both ways if the property value declines.
  2. Illiquidity prevents human error – Real estate transactions have high costs and take significant effort. This is usually enough to deter investors from making hasty, panic-induced decisions during market volatility. Poor decisions are more prevalent in the stock market, where selling investments can happen in seconds with no material transaction costs.

Real estate also receives tax benefits from capital gain exclusions on primary homes to rental depreciation on investment real estate; however, this is somewhat offset by holding property tax costs, which stocks do not incur.

Converting a Primary Residence to an Investment Property

When moving on to a new house, some individuals decide to convert their original home into a rental property that becomes an income source.

You can convert your primary residence into a rental property by making a few smart moves. You start by determining your property’s tax basis to calculate depreciation during the rental period. When you eventually sell, this will factor into gain/loss calculations. The conversion date varies in your favor based on whether there was a gain or a loss.

Once you’ve converted your primary residence into a rental property, you must adhere to landlords’ tax rules, but with that, you will gain a number of favorable benefits. You can deduct real estate taxes and mortgage interest on a rental property, and you do not have to pay self-employment tax on landlord income. You can write off your operating expenses, such as maintenance and repairs, association fees, utilities, and lawn care. You can also depreciate the cost of the property over 27.5 years, even if the value increases. This depreciation can offset a significant portion of your rental property income, which translates to very low taxes on this income stream. You may run into issues if you have a tax loss, but you should be able to offset this over time with increasing rents. When you sell the investment property, you can use a 1031 exchange and defer taxes if you “swap” the property with another investment property of like kind and equal or greater value.

It is also important to carefully weigh the costs of being a landlord. To start, rent must cover all carrying costs, as you certainly do not want an asset to cost you money. Also, you need to make an allowance for unexpected periods where you may not have a tenant and would have to float the carrying costs out of pocket. A mistake you often hear of is an investor who over-leveraged and owned ten houses, then had to sell them all at a loss in a downturn.

Perhaps more importantly, you should never ignore the qualitative question of whether or not you want to be a landlord. It can be time-consuming and even take an emotional toll on you as you worry about the property or your tenants. Not everyone wants to deal with late rent payments, requests to fix bathrooms and leaky ceilings, or property damage caused by untrustworthy tenants.

In this four-part series, we covered answers to many of the questions that come up when our tech founder clients consider a real estate purchase.

In Part 1, we offered founders a framework to decide whether renting or buying is the right choice. Part 2 explored how a home purchase could potentially fit into your overall financial plan. Part 3 of the series discussed real estate financing options, taking into account the entire process, including risk, taxes, cost savings, profit, and legalities. And in Part 4, we dove into the topic of real estate as a financial asset, examining common misconceptions and opportunities.

This concludes the series. We hope you’ll find this information helpful as you think through your decisions related to real estate and navigate your next steps.

This article is Part 4 of the Guide to Real Estate series. Click here to read Part 1, Part 2, or Part 3.The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

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Will you help me solve any and all financial problems I may encounter?

Yes, and it’s likely we’ve helped others solve similar problems as well such as business sales, QSBS, tax minimization, estate, 401(k) plans, IRS audits, family deaths, disability, real estate, debt, social security, Medicare, health insurance, college, gifting, and most other financial issues.

What types of clients do you specialize in?

We work specifically with tech founders.

What services do you provide?

A relationship with Keystone involves comprehensive financial planning around retirement, insurance, estate planning, tax planning, and investment management.

How do you help clients implement their financial plans?

We firmly believe that even the best financial plan is of little value until it’s implemented. To help you achieve your goals without feeling stressed or overwhelmed by the noise along the way, we will work together to make the necessary decisions then we take care of the execution.

Are your recommendations truly in my best interest?

As an SEC Registered Investment Advisory firm, we are held to a fiduciary standard, which legally requires us to do what is in our clients’ best interests. This differs drastically from some of our competitors who are only held to the “suitability standard,” meaning that our competitors can make recommendations that are suitable but may not be in the clients’ best interests. Our commitment to an honest and ethical culture has allowed us to build deep, trusted relationships with our clients.

What are all the different ways you get paid?

We are only paid via one management fee. We believe this allows us to have an unbiased framework to select the best investments for you and to give you advice tailored to your needs, not ours. We believe compensation drives behavior, and the way someone is paid influences the work they do. Many financial firms have complex fee arrangements; we do not.

Why would I choose you as my advisor and not do it myself?

There’s certainly a possibility that if you put enough focus and energy into it, you could do it all yourself. But like everyone else, your time is limited and most people prefer to focus on family or business. We’re here to free up your time while leveraging our wealth of experience in addressing concerns, presenting solutions, and working toward your financial goals.

What are the benefits of working with an independent advisor compared to a bank or large advisory firm?

Our independent and conflict-free approach allows us to find the best solutions for our clients. This gives you the advantage since larger firms might be compelled to make specific recommendations, sell proprietary products, or may be restricted in the advice and services they offer. We offer guidance customized to your needs and goals which is a personalized level of service, care, and attention larger firms just can’t provide.

Do you use proprietary funds?

At Keystone, we do not use proprietary products. We do not receive commissions or backend fees from any third parties. We do not earn compensation for recommending one fund vs. another. We believe this allows us to have the most unbiased framework to select the best investments for you and to provide advice tailored to your needs, not ours.

Where do you keep my money and how can I see it?

For your convenience and safety, we use Charles Schwab as the custodian for the majority of our client assets. Schwab administers more than $7 trillion dollars and we selected them to care for yours as well based on a variety of criteria including safety of assets, financial strength, and ease of use. As custodian, Schwab holds your funds and provides direct reporting to you. Your funds will be held in accounts under your name and can be viewed anytime online at Schwab.

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