How to create wealth is not easy but let’s face it there are only a few ways to create real wealth that keeps ahead of inflation.
Apart from winning money or receiving an inheritance, most people have to work a job or run a business to earn a living. But unless you invest your savings in real estate your long-term prospects for generating wealth will be at a disadvantage.
So let’s consider the ways to make money before determining why real estate is the best way to generate wealth.
1. Employment
For most people working a job is the only way they can earn money and possibly save for the future. Most people have to start life working a job to earn money as they have no capital to start a business. Unless you are lucky enough to have won money or been gifted a large amount of capital from a deceased estate and live off the investment returns.
However, employment is the least effective method to create wealth. There are many barriers to earning a good salary and building wealth.
Trade Your Time for Money
Firstly you have to trade your limited time for money. You can only earn a limited amount of money per hour and only work a limited number of hours per week. Secondly, the amount of money earned is constrained by the type of job. Another barrier to earning good money is your level of knowledge and experience. It can take years of work experience and additional education before you slowly climb the corporate ladder and earn a reasonable salary.
Building up savings from working is difficult when you are young and inexperienced as you will only earn a basic wage. And for many people the increase in the cost of living consumes any increase in gained earning capacity.
Mostly in today’s world there are just too many older people in all the good jobs and it’s very difficult for younger people to climb up to that level. Only when you are middle aged or older you may be able to work and save a good proportion of your income to add to your overall wealth.
The best chance a young person has to quickly climb the ranks in a job is to get into a new industry where there are not many older people at the top. Information technology was one such industry.
Overall, very few people become rich working a job!
2. Run a Business
Starting a business has many entry barriers.
Competition is the main entry barrier to starting a successful business. Unless you are in a new industry there will be many other businesses competing for the same customers. A new business would need to offer better products or services at a lower price to break into an established market.
Many businesses are capital intensive. You would require a lot of money to buy an established business or fund a business start-up. There is the cost of leasing premises, shop fit-outs, furniture, equipment, inventory, hiring staff and advertising before you have made your first sale. And it can take months or years to attract and retain enough customers to make a healthy profit. This prevents many people from owning or operating a business.
Many businesses are labor intensive. The business needs to hire, train and manage many staff to provide the service.
Most small businesses are operated by someone who has invested money to effectively buy themselves a job. Whether you buy an established business or start up from nothing you need the initial capital to get started. The business owner is now trading their time for money but has the added burden of running a business.
To create wealth from a business, the business needs to grow and generate an increasing income stream to increase the value of the business. However, many start-ups fail to make money and the owner is forced to close down the business.
Most people who purchase an established business rarely increase the size of the business and therefore do not increase their wealth.
3. Income Growth
Creating or purchasing an asset that generates an increasing income stream.
In a job or business there needs to be income growth to at least keep up with the rate of inflation.
However, to create wealth you need to outpace the rate of inflation.
Stocks and real estate generate income in the form of rents and dividends. Property rents are increased to keep up with inflation and companies pay increasing dividends over time.
While you cannot make an improvement to stocks, you can make improvements to real estate to increase its value and income producing capacity.
4. Capital Improvement to Create Wealth
One way to create wealth is to buy an asset and make improvements to increase the value.
The best example is house flipping where a person buys a rundown home and renovates the home to a new condition. Then sell the home for a profit. House flipping can be profitable but you really need to have strong budgeting skills and know how to keep your expenses under control.
Please read Does Renovation Increase the Value of a Home?
The other most common way is to purchase raw materials and manufacture a product.
5. Capital Appreciation to Create Wealth
Creating or purchasing an asset that appreciates in value over time is one way to create wealth.
The most obvious example is purchasing real estate. All property appreciates over time but some types of property appreciate faster than others. The main issue is having initial capital and the capacity to borrow money to purchase a property.
Purchasing stocks on the stock market is another type of investment. If you don’t know a lot about stocks you are better off investing into a managed fund that handle the stock trading for you. You can borrow to purchase stocks but at a much higher risk profile than real estate.
Conclusion
One of the key reasons that Real Estate is the best way to create wealth is that it is one of the few investments that keeps up with or exceeds inflation. After all, we only have one planet Earth and real estate is a limited resource. The world’s population is increasing and everyone has to live somewhere. So the demand for housing can only increase over the longer term.
Residential real estate can fall backwards during periods of economic recession but generally it always increases in value over the medium to longer term. After all, people tend not to give away their homes (which for most people is their life savings) in a poor market unless they are forced to do so by adverse financial circumstances.
Stock markets can rapidly fall because it’s easy to sell off the stocks. People do not really need stocks but they do need homes to live in.
The most important rule of investing is to protect your capital and real estate meets this requirement.
The most important reason for investing in real estate is that it is a capital appreciation and preservation mechanism. Once you have built up your wealth you don’t want to see it erode away from inflation or become obsolete in any way. Trends will change over time but real estate will never become obsolete as people need somewhere to live and bring up their families.