Real estate investing is one of the most popular ‘side gigs’ we talk about on Physician Side Gigs, so much so that we have a whole free Real Estate Education Series that is dedicated to it. However, as with anything in life, it’s important that you know why you invest in something, and not just go down this route out of FOMO or because your friends or colleagues are doing it.
One question that often comes up on the communities is how investing in real estate is better than investing in the stock market, as both have had great historical results and on the whole, investing in index funds is a lot easier and more passive than being a good real estate investor.
Don’t get me wrong - my family is a big fan of the concept of index fund investing, and we often talk about hassle free investing in a three fund portfolio or modified three fund portfolio. That said, real estate has been both an important part of our financial plan, and one that has been extremely beneficial for us over the past decade.
This article goes into why you may want to consider real estate as both a means of diversification within your investment portfolio and as a cornerstone to financial freedom.
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Why Physicians Like Investing in Real Estate
There’s no question that real estate investing is harder than investing in a more set it and forget type model three-fund portfolio or target date fund. That said, more and more physicians are gravitating towards real estate investing, as it offers an opportunity to make significant money by leveraging their clinical earnings, instead of starting a side gig from scratch, which often requires a combination of hard work with things like branding, networking, coming up with a unique idea and business proforma, as well as often times, an element of luck. Real estate is a hard asset that has a physical value to it, and though real estate values can fluctuate and there is always a risk with investments, there are tried and true methods to success in real estate investing with careful discipline and educated decision making based on numbers.
In today’s market with rising interest rates and property prices still sitting high, it’s easy to question if investing in real estate is worth it. We know that historically, a diversified investment into the stock market will yield 6-10% returns annually on average. While over the past decade, real estate has significantly outperformed that number (as has the stock market), many will point out that today’s cash on cash returns in real estate are similar to those historic returns in the market, but with added hassle and risk.
It’s important to keep in mind that interest rates over the past decade have been the lowest in 50 years, with the average 30 year interest rate from 1971 to 2023 being 7.74%. Despite that, people have been investing in real estate for many decades, and there’s a reason why so many of the world’s richest people own real estate. Let’s get into these.
Most real estate investments will produce cashflow (or at least we hope they do if underwritten correctly). This means the money coming in from the income of the property, usually rental income, is in excess of the expenses of the property, including the mortgage payments, taxes, insurance, maintenance, and other costs such as management fees.
Our syndications and other real estate investments provide us with cash on a regular basis. If you’ve watched some of our real estate education series, you may have heard me talk about the benefits of cashflow both in financial freedom and in making you feel wealthier today.
One thing we talk about a lot as a benefit of side gigs for physicians is the power to walk away from a bad situation (which increasingly, there feels like there are more of for employed physicians) or to cut back clinically to reduce burnout. When you only have one income stream, you may feel trapped at your job because you rely on that income to pay your mortgage, pay down your student loans, and cover all of your expenses. Your employers know that, and you lose leverage in contract negotiations. When you have other sources of income, you are more able to stomach the idea of being without a job for a few months or cutting back on call and sacrificing some income. When there are black swan events such as the early pandemic when many physicians were not being paid, we weren’t financially stressed, because our income from our properties was more than sufficient to pay our expenses and actually even gave us money to invest at a time where it was great to buy because the market had lost so much value.
Like many physician families who have their eyes on financial independence, we regularly contribute to our retirement accounts and put away money in our taxable accounts. However, that money doesn’t make us feel wealthier today - in fact, we’ll likely never touch it until we have required minimum distributions from our retirement accounts. It’s harder to stomach doing a home renovation or taking that trip of a lifetime if you have to pull money out of your investments to do so, so psychologically, many of us don’t realize how well we’re doing financially until much later on in our careers when we see how well compounding returns have done.
#2 Potential for Appreciation
The hope that we all have when we invest in real estate is that in addition to the rental income being generated from the property, the property itself will appreciate in value. This could happen in multiple ways:
Naturally because land tends to go up in value over time
You buy in an area that’s in the pathway of progress and the area significantly increases in value or there’s a shortage of properties like yours, thus allowing you to raise rent or making your property in high demand on the market
You’re able to increase the market value of the property by showing great income potential through careful management of the property and good tenants and reducing your costs or adding revenue streams onto the investment
#3 Tax Benefits
On our communities, we regularly hear physicians talking about how high their taxes are and how few deductions they have access to. If you’re a W-2 physician, there are limited tax deductions that you can take under the tax code, which heavily favors business and real estate owners. Real estate investments offer many outlets for tax savings, and remember, the more money that you have working for you today, the faster your track to financial independence. As always, note that we are not accountants and you should consult appropriate expertise before taking action based on these ideas, which are not individualized to your personal situation.
QBI deduction from income from REITs - this portion of the tax code currently allows you to deduct 20 percent of qualified real estate investment trust (REIT) dividends
Can write off expenses related to your real estate business (for example if you have a short term rental and travel to visit the property, that is a legitimate write off)
Depreciation - This is a complicated concept with nuances that should be discussed with an accountant with experience in real estate, but basically while your investment itself may be increasing in value, the IRS allows you to depreciate the hard assets of your building over time according to a set schedule on your tax return. This can be written off against the profits of the cash flow, which is part of the reason you hear some real estate investors saying that they don’t pay taxes on their cashflow. You may even hear some people talking about the concept of bonus depreciation, which allows you to accelerate that schedule and take the vast majority of the depreciation in a given year.
1031 exchange - many real estate investments will allow you to roll your profits into the next property, allowing you to defer taxes on the capital gains indefinitely. You can actually pass down the property to your heirs, and at the time of your death, the property will incur a step up in basis, meaning that the tax basis of the investment will reset to its current value, and your heirs will not have to pay taxes on the profits that were incurred during your lifetime.
Unique ways to use your real estate related “losses” to offset your active income from other sources, like your physician income. While typically your real estate “losses” from those expenses and depreciation can mostly be used to offset your real estate income or other sources of passive income, there are some cases where you can actually offset your active income.
Real Estate Professional Status
Short Term Tax Loophole
These are often talked about in our communities and our real estate education events, and we’ll write a separate article about them soon, but you can learn more about those on our tax strategy for the W-2 physician page in the meantime.
#4 Potential for Infinite Returns
If your property appreciates significantly either because of market forces or because you forced appreciation of the property through material improvements to the property, you can actually do a cash out refinance on the property and take out the money that you initially invested for your down payment. You can then use that money for other investments, while this investment continues to generate income through the methods above. This is the concept of infinite returns!
#5 Somebody Else Is Paying Down Your Debt
While investing in a property directly may seem like a pain (and remember, it doesn’t have to be if you hire a good property manager to do the heavy lifting for you), one of the coolest things about renting out your property is that the monthly rent that somebody else is paying is actually paying down your mortgage. So while you may put down that initial down payment on the property, eventually you are going to own the entire property outright, while somebody else paid the mortgage payment and related expenses. When you sell the property, all of the profits from the property and the down payment plus the portion of the mortgage payments that went to principal come to you!
As you can see, there are many reasons to consider diversifying your investment portfolio with real estate, even though there’s a learning curve that you need to undergo to do it intentionally and successfully. While it’s not for everyone, we hope this article at least shed some light on why so many physicians love real estate as a cashflowing and wealth building tool!