Getting started with Real Estate investing can be nerve-wracking. Often, people assume buying a property is “risky.” It certainly can be, without proper market knowledge or overpaying. As the saying goes, “you make your money when you buy.” That is why it is imperative that you educate yourself or partner with an experienced investor before investing your hard earned money.
Below, I will highlight the great reasons real estate is the ideal investment to put your money to work for you and create a lasting legacy for generations to come
Cash flow is the leftover amount of money from rental Income after ALL expenses have been paid. It is important to remember that if you are going to be taking out a loan (Mortgage) on the property, that you include mortgage and interest payments into this calculation.
Below is a simplified monthly outline for a Single Family House with a single car garage, which you realized you can rent out as well, due to lack of on-street parking 🙂
Rental Income $1500
Income from a Garage: $150
Total Income: $1650
Mortgage and Interest: $800
Total Expenses: $1000
CASH FLOW: $1650-$1000= $650
Owning rental property allows the owners to take extra deductions associated with both their rental property and potentially their full time W-2 Income. Generally, you can deduct the costs of owning, operating, and managing a property.
Another cool tax benefit is something called Depreciation. On a 27.5 year amortization schedule, you can deduct the “expense” of your property, thereby resulting in a “loss” and using that toward shielding your rental income. Confused? Let me explain
Say you buy a property worth $1,000,000.
Depreciated on a 27.5 year schedule, this is a “depreciation expense” of ~$36,364 per year.
If your property earns cash flow of lets say, $45,000, you can “write-off” $36,364 as an “expense”, showing net taxable income of $8,636.
The cool part over here is that your property did not actually incur this expense of $36,364. This is just a gift from the IRS, so to speak.
Additionally, a cool part of this whole equation is that while your property was “depreciating in value”, it was actually appreciating in value. Uh oh, did I confuse you again? Maybe this next part will help.
Now for appreciation, there are two main types. Firstly, there is market appreciation and the second is forced appreciation.
Market appreciation is the natural rise in a piece of real estate value, commonly due to inflation and natural market trends. Over time, real estate, as well as other investment vehicles like the Stock market, tend to increase over time (obviously shorter term stretches may lead to significant downfalls, but generally a long term plan will allow you to recoup these temporary losses).
On the other hand, an investor can force the appreciation of the property by addressing property inefficiencies like repairing units and increasing rents, while finding ways to decrease unneeded expenses. It is important to remember that multifamily properties (5+ units), have a value based on its overall bottomline NOI (net operating income). Meaning increasing the income or decreasing any expenses should result in a higher property valuation. Simply put, if an owner can identify a property to buy that has lower than market rents, and/or higher expenses, then a new owner can come in and maximize the value of the building by fixing any maintenance issues and ultimately forcing the value of the building to increase.
When you buy a rental property, you have two choices: Pay all cash or get a loan. (Technically there are other ways, but we don’t need to get technical)
Due to the security and real estate and the fact that the asset is tangible, financing is easily attainable from banks or private lenders who are eager to lend you money for your real estate project.
Some investors like to buy their properties with cash (AKA without debt). However, they are missing out on an extremely lucrative tool known as leverage. Leverage, in essence, is leveraging a bank’s funds to close on each deal you do.
For example, if you have $100,000 to invest into a home that costs exactly $100,000 and will have cash flow of $6,000 each year, you can choose to pay all cash for it, which will yield a 6% return on your money ($6,000 cash flow / $100,000 Purchase).
However, if you leverage a bank loan, you only need to put a down payment of 25% of the purchase price. So instead of putting in your entire nest egg of $100,000, you will put in $25,000 (plus closing costs). In this case, because you took out a loan from a bank, you now have an additional mortgage expense which will lower your cash flow from $6,000 to $3,900. However, your return on investment jumps from 6% to almost 16%, all because you used leverage. ($3,900 Cash flow / $25,000 initial investment = 15.6%). Aside from the power of leverage, real estate has another major incentive not found in other investment vehicles, and that is Equity Build and loan paydown
Equity and Loan Paydown
When you get a loan for a rental property, you may think the monthly mortgage payments are a liability. However, this seemingly “bad” debt is actually a great debt, when used correctly. Say your monthly rental income is $2000. If all your expenses, including your mortgage payments are $1650, then you are receiving $350 in cash flow, but your tenants are building your equity. While this equity isn’t tangible cash, it increases your wealth and your net worth, which translates into more assets either through a refinance or sale as you have a greater amount of ownership in a property that is increasing in value.
Real Estate offers investors benefits far greater than just the standard cash flow we’d expect to receive from a rental. Through the tax benefits, depreciation and appreciation, as well as having our tenants pay down our mortgage, the wealth building streams are numerous. If you have any questions regarding any of these topics, please feel free to reach out to me by email Jason@3pillarsrei.com or speak with a real estate professional or CPA for greater clarification.