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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?”
Want to learn about how to fund your NEXT flip project with private money, click here to find out more.
One of the best way and simple ways to fund your investments in real estate and diversify your existing investments is to roll-over your IRA into a self-directed IRA. Curious? Click here to find out more.
By now, you know that real estate investing is not a walk in the park, but it provides tremendous opportunities to build real wealth, offers a path to financial independence, and offers a unique method to diversify your existing investments even if being an active investor is not for you.
Chapter 9: Find Your Why– from What the 1% Know: How Everyday People Use Real Estate to Build Wealth
If you have skipped over the investor interviews in this book, go back and read them before moving on. There is so much experience and wisdom shared there that it’s impossible to overestimate their value. So why do I now want to talk about a soft subject like purpose, and what in the world is internal capital?
Investing in real estate will require you to learn about the building and renovation of buildings, financial analysis, and banking and finance. It will help you to grow in your ability to form teams, manage them, and produce results. You will not be required to be an expert in any of these areas, but you need to know enough to hire, manage, and evaluate people who are.
You do not need to build an empire of thousands of units, but you could. For all these reasons, defining why you are doing this is vitally important. Consider the following quote:
“Compare yourself to yesterday, not to younger people who are not you. Everyone progresses at a different rate, so don’t let anyone else make you feel left behind. You probably don’t even know where you are going, so feeling behind doesn’t help.
“Approach your own personal voyage and projects like Michelangelo approached a block of marble, willing to learn and adjust as you go, and even to abandon a previous goal and change directions entirely should the need arise.”
—From Range by David Epstein
As you research real estate investing, you’ll hear a lot about financial freedom and FIRE: Financial Independence Retire Early. I am going to share some insights about freedom and purpose here.
First, there is no freedom outside of your core values and principles—your why. Your purpose could be to leave your 9-to-5 job. It could be to invest on the side as you continue to work or even after you retire. Think of a ship readying to sail: Determining your destination is important. Isn’t it? Your core values are the rudder that allow you to steer your ship and maintain control. Your destination can change, or you can have more than one, but you need to have one. And determining why you are sailing is essential. But also, your values, how you steer your ship as you sail, are important as well. Honesty, trust, diligence, and a willingness to learn from failures are good ones to start with. What others would you add?
Second, there is no freedom without responsibility. I remember the story of a young man who complained to his parents and teachers about all the rules and expectations placed upon him. His response was to join the Army. I’m sure you can guess how that worked out. He thought this would give him freedom, but before he could have any freedom within this new system, he would have to learn an entire new level of responsibility. If we want freedom, financial and otherwise, we need to take responsibility for our actions.
Third, there is no freedom without results. In life, effort is not enough, nor are ideas. You have to endeavor to sail your ship to its destination, using the tools of your purpose and core values to get you there. You had to learn how to win and how to lose growing up. Your results in life apply to investing in real estate and any activity. When you learn from your wins and losses, it provides a compounding effect. Just as small deposits of money earn interest over long periods of time, so do our actions.
What powers your journey is tapping into your internal capital. As an investor, you know that using your monetary capital to invest in properties that can provide cash flow, appreciation, equity, and leverage provides almost unlimited power. Learning how to use them determines everything. Your internal capital is your inner resources. These include your confidence, knowledge, and unique experiences in life. This could include your faith tradition. It is the ability to find hope when faced with difficulty. It is the ability to learn from failures, to get up and start again. It is the ability to cultivate gratitude as a daily mindset, something you choose each morning and end each day with. I want to leave you with my favorite poem, one that has always remained valuable to me:
Gratitude unlocks the fullness of life. It turns what we have into enough, and more. It turns denial into acceptance, chaos to order, confusion to clarity. It can turn a meal into a feast, a house into a home, a stranger into a friend. It turns problems into gifts, failures into successes, the unexpected into perfect timing, and mistakes into important events. It can turn an existence into a real life, and disconnected situations into important and beneficial lessons. Gratitude makes sense of our past, brings peace for today, and creates a vision for tomorrow.