Why and How Real Estate is an IDEAL Investment
Unique Aspects of Real Estate
Learning how to harness these, to feel confident in making decisions using these concepts and harnessing them to benefit you and your family is probably the most important lesson in this book. The Case Studies and insights from interviews with other investors will highlight how they can be applied to your life and journey toward financial independence.
“Cash flow is the money you have left over from the rent you’ve collected after all expenses have been paid. Most real estate has expenses such as a mortgage, property taxes, insurance, maintenance, and property management fees. When you buy a property that pulls in more rent each month than the expenses you carry to own it, your cash flow is positive.”
In purchasing a property as an investment, this should be our priority.
“Appreciation, or the rising of home prices over time, is how the majority of wealth is built in real estate. This is the “home run” you hear of when people make a large windfall of money. While prices fluctuate, over the long run real estate values have always gone up, always, and there is no reason to think that is going to change.” This is a long-term benefit and while over the long term is quite reliable, it alone should not be the primary reason to acquire a property. In any time period and market, the value of a property can decline or fluctuate and the factors contributing to this are largely beyond your control.
When you receive income from a job or any activity that produces a W-2 or a 1099, taxes such as social security, medicare, federal, state and local income taxes are deduced first from your gross income. With real estate income, expenses such as depreciation and business expenses such as insurance, property taxes and other items are deducted first before your taxable income is determined. Your income is taxed at different rates as well, most of the time at lower rates. This is a little understood benefit and yet it is available to the investor at any level. Be sure to discuss this with your CPA and Tax Advisor.
“Even though the name can be deceiving, depreciation is not the value of real estate dropping. It is actually a tax term describing your ability to write off part of the value of the asset itself every year. This significantly reduces the tax burden on the money you do make, giving you one more reason real estate protects your wealth while growing it.”
“Each year, on the residential real estate you have invested in, you can write off 1/27.5 of the properties value against the income you’ve generated. So for a house you bought for $200,000, you would divide that number by 27.5 to get $7,017. This is the amount you could write off the cash flow you earned for the year from that property. Many times, this is more than the entire cash flow and you can avoid taxes completely.”
Other Deductable Business Expenses
Depreciation is not the only item that can reduce your taxable income. Related business expenses can also. You should always consult with a qualified CPA to determine what business expenses can be legally reduce your taxable income, but there are many.
“If cash flow and rental income is my favorite part of owning real estate, leverage is a close second. By nature, real estate is one of the easiest assets to leverage I have ever come across—maybe the easiest. Not only is it easy to leverage the financing of it, but the terms are incredible compared to any other kind of loan. Interest rates are currently below 5%, down payments can be 20% or less, and loans are routinely amortized over 30-year periods. What else can you invest in using financing with terms like that?” Many business enterprises are more or less a way to create a job. This is a time honored tradition and in the words of my grandfather, “all work is valuable.” It is but most businesses are not seen as assets than a bank or others would loan money to and be seen as a reliable asset. Real estate is and being able to leverage this gives you an amazingly effective tool.
Loan Paydown Builds Equity
“When you take out a loan to buy real estate, you typically pay it back with the rent money from the tenants. One of the best parts of investing in real estate is the fact that not only are you cash flowing, but you’re also slowly paying down your loan balance with each payment to the bank.” Just like when you pay your own mortgage, the principal is paid down over time and the equity is built up. With a rental property, the tenant is making those payments and you, as the owner reap the benefits.
“Forced equity is a term used to refer to the wealth that is created when an investor does work to a property to make it worth more. Unlike appreciation, where you are at the mercy of the market and factors you cannot control, forced equity allows investors an option where they can have a hand in increasing their properties value.”
“The most common form of forced equity is to buy a fixer-upper type property and improve its condition. Paying below market value for a property that needs upgrades, then adding appliances, new flooring, paint, etc. can be a great way to create wealth through real estate without much risk. While this is the most common method, it’s not the only one.”
“Let’s take a moment to consider how inflation affects real estate prices. In general, overall, our money supply is worth less and less with each passing year. As the value of money decreases, the price of goods and services increases. Many of us take this for granted and don’t think about it much. It’s not uncommon to hear about how five cents used to buy a bottle of coke, or a hamburger could be purchased for a dime. While it’s easy to take for granted, it’s actually an incredibly powerful wealth-building tool when harnessed appropriately.” If you took $20,000 and just put it under your mattress, and kept it there for ten years, after that time what that money could purchase would be much less, due to inflation.
“The key to using inflation to build wealth in real estate lies in the fact the majority of your big expenses (mortgage, property taxes) stay fixed for the majority of the time you own the property. When you combine this with rising rents and home values (due to inflation), you start to see big results. If we know it’s reasonable to expect inflation to continue, why not invest in an asset where this will benefit you?”