The Top 5 meaningful Benefits of Purchasing and Owning Investment Real Estate
So… You may ask yourself, why should you buy or invest in real estate in the First Place? Because it’s the IDEAL investment! Let’s take a moment to address the reasons why people should have investment real estate in the first place. The easiest answer is a well-known acronym that addresses the meaningful benefits for all investment real estate. Put simply, Investment Real Estate is an IDEAL investment. The IDEAL stands for:
• I – Income
• D – Depreciation
• E – Expenses
• A – Appreciation
• L – Leverage
Real estate is the IDEAL investment compared to all others. I’ll explain each assistance in thoroughness.
The “I” in IDEAL stands for Income. (a.k.a. positive cash flow) Does it already generate income? Your investment character should be generating income from rents received each month. Of course, there will be months where you may experience a vacancy, but for the most part your investment will be producing an income. Be careful because many times beginning investors embellish their assumptions and don’t take into account all possible costs. The investor should know going into the buy that the character will COST money each month (otherwise known as negative cash flow). This scenario, although not ideal, may be OK, only in specific instances that we will discuss later. It boils down to the risk tolerance and ability for the owner to fund and pay for a negative producing asset. In the expansion years of real estate, prices were sky high and the rents didn’t increase proportionately with many residential real estate investment similarities. Many naïve investors purchased similarities with the assumption that the appreciation in prices would more than compensate for the fact that the high balance mortgage would be a meaningful negative impact on the funds each month. Be aware of this and do your best to forecast a positive cash flow scenario, so that you can truly realize the INCOME part of the IDEAL equation.
Often times, it may require a higher down payment (consequently lesser amount being mortgaged) so that your cash flow is permissible each month. Ideally, you ultimately pay off the mortgage so there is no question that cash flow will be coming in each month, and significantly so. This ought to be a vital part to one’s retirement plan. Do this a few times and you won’t have to worry about money later on down the road, which is the main goal in addition as the reward for taking the risk in purchasing investment character in the first place.
The “D” in IDEAL Stands for Depreciation. With investment real estate, you are able to utilize its depreciation for your own tax assistance. What is depreciation anyway? It’s a non-cost accounting method to take into account the overall financial burden incurred by real estate investment. Look at this another way, when you buy a brand new car, the minute you excursion off the lot, that car has depreciated in value. When it comes to your investment real estate character, the IRS allows you to deduct this amount yearly against your taxes. Please observe: I am not a tax specialized, so this is not meant to be a lesson in taxation policy or to be construed as tax advice.
With that said, the depreciation of a real estate investment character is determined by the overall value of the structure of the character and the length of time (recovery period based on the character kind-either residential or commercial). If you have ever gotten a character tax bill, they usually break your character’s assessed value into two categories: one for the value of the land, and the other for the value of the structure. Both of these values additional up equals your total “basis” for character taxation. When it comes to depreciation, you can deduct against your taxes on the original base value of the structure only; the IRS doesn’t allow you to depreciate land value (because land is typically only APPRECIATING). Just like your new car driving off the lot, it’s the structure on the character that is getting less and less valuable every year as its effective age gets older and older. And you can use this to your tax advantage.
The best example of the assistance regarding this concept is by depreciation, you can truly turn a character that creates a positive cash flow into one that shows a loss (on paper) when dealing with taxes and the IRS. And by doing so, that (paper) loss is deductible against your income for tax purposes. consequently, it’s a great assistance for people that are specifically looking for a “tax-shelter” of sorts for their real estate investments.
For example, and without getting too technical, assume that you are able to depreciate $15,000 a year from a $500,000 residential investment character that you own. Let’s say that you are cash-flowing $1,000 a month (meaning that after all expenses, you are net-positive $1000 each month), so you have $12,000 total annual income for the year from this character’s rental income. Although you took in $12,000, you can show by your accountancy with the depreciation of the investment real estate that you truly lost $3,000 on paper, which is used against any income taxes that you may owe. From the standpoint of IRS, this character realized a loss of $3,000 after the “expense” of the $15,000 depreciation amount was taken into account. Not only are there no taxes due on that rental income, you can utilize the paper loss of $3,000 against your other regular taxable income from your day-job. Investment character at higher price points will have proportionally higher tax-shelter qualities. Investors use this to their assistance in being able to deduct as much against their taxable amount owed each year by the assistance of depreciation with their inner real estate investment.
Although this is a greatly important assistance to owning investment real estate, the subject is not well understood. Because depreciation is a slightly complicated tax subject, the above explanation was meant to be cursory in character. When it comes to issues involving taxes and depreciation, make sure you have a tax specialized that can advise you appropriately so you know where you stand.
The “E” in IDEAL is for Expenses – Generally, all expenses incurred relating to the character are deductible when it comes to your investment character. The cost for utilities, the cost for insurance, the mortgage, and the interest and character taxes you pay. If you use a character manager or if you’re repairing or improving the character itself, all of this is deductible. Real estate investment comes with a lot of expenses, duties, and responsibilities to ensure the investment character itself performs to its highest capability. Because of this, current tax law generally allows that all of these related expenses are deductible to the assistance of the investment real estate landowner. If you were to ever take a loss, or deliberately took a loss on a business investment or investment character, that loss (expense) can carry over for multiple years against your income taxes. For some people, this is an aggressive and technical strategy. however it’s another possible assistance of investment real estate.
The “A” in IDEAL is for Appreciation – Appreciation method the growth of value of the inner investment. It’s one of the main reasons that we invest in the first place, and it’s a powerful way to grow your net worth. Many homes in the city of San Francisco are several million dollars in today’s market, but back in the 1960s, the same character was worth about the cost of the car you are currently driving (probably already less!). Throughout the years, the area became more popular and the need that ensued caused the real estate prices in the city to grow exponentially compared to where they were a few decades ago. People that were lucky enough to recognize this, or who were just in the right place at the right time and continued to live in their home have realized an investment return in the 1000’s of percent. Now that’s what appreciation is all about. What other investment can make you this kind of return without drastically increased risk? The best part about investment real estate is that someone is paying you to live in your character, paying off your mortgage, and creating an income (positive cash flow) to you each month along the way throughout your course of ownership.
The “L” in IDEAL stands for Leverage – A lot of people refer to this as “OPM” (other people’s money). This is when you are using a small amount of your money to control a much more expensive asset. You are essentially leveraging your down payment and gaining control of an asset that you would typically not be able to buy without the loan itself. Leverage is much more permissible in the real estate world and inherently less risky than leverage in the stock world (where this is done by method of options or buying “on Margin”). Leverage is shared in real estate. Otherwise, people would only buy character when they had 100% of the cash to do so. Over a third of all buy transactions are all-cash transactions as our recovery continues. nevertheless, about 2/3 of all purchases are done with some level of financing, so the majority of buyers in the market enjoy the strength that leverage can offer when it comes to investment real estate.
For example, if a real estate investor was to buy a house that costs $100,000 with 10% down payment, they are leveraging the remaining 90% by the use of the associated mortgage. Let’s say the local market improves by 20% over the next year, and consequently the actual character is now worth $120,000. When it comes to leverage, from the standpoint of this character, its value increased by 20%. But compared to the investor’s actual down payment (the “skin in the game”) of $10,000- this increase in character value of 20% really method the investor doubled their return on the investment truly made-also known as the “cash on cash” return. In this case, that is 200%-because the $10,000 is now responsible and entitled to a $20,000 increase in overall value and the overall possible profit.
Although leverage is considered a assistance, like everything else, there can always be too much of a good thing. In 2007, when the real estate market took a turn for the worst, many investors were over-leveraged and fared the worst. They could not weather the storm of a correcting economy. Exercising caution with every investment made will help to ensure that you can buy, retain, pay-off debt, and grow your wealth from the investment decisions made as opposed to being at the mercy and whim of the overall market fluctuations. Surely there will be future booms and busts as the past would dictate as we continue to move forward. More planning and preparing while building net worth will help prevent getting bruised and battered by the side effects of at any rate market we find ourselves in.
Many people think that investment real estate is only about cash flow and appreciation, but it’s so much more than that. As mentioned above, you can realize several benefits by each real estate investment character you buy. The challenge is to maximize the benefits by every investment.
Furthermore, the IDEAL acronym is not just a reminder of the benefits of investment real estate; it’s also here to serve as a guide for every investment character you will consider purchasing in the future. Any character you buy should conform to all of the letters that represent the IDEAL acronym. The inner character should have a good reason for not fitting all the guidelines. And in almost every case, if there is an investment you are considering that doesn’t hit all the guidelines, by most accounts you should probably PASS on it!
Take for example a story of my own, regarding a character that I purchased early on in my real estate career. To this day, it’s the biggest investment mistake that I’ve made, and it’s precisely because I didn’t follow the IDEAL guidelines that you are reading and learning about now. I was naïve and my experience was not however fully developed. The character I purchased was a vacant lot in a gated community development. The character already had an HOA (a monthly maintenance fee) because of the nice facilities facilities that were built for it, and in anticipation of would-be-built homes. There were high expectations for the future appreciation possible-but then the market turned for the worse as we headed into the great recession that lasted from 2007-2012. Can you see what parts of the IDEAL guidelines I missed on completely?
Let’s start with “I”. The vacant lot made no income! Sometimes this can be permissible, if the deal is something that cannot be missed. But for the most part this deal was nothing special. In all honesty, I’ve considered selling the trees that are currently on the vacant lot to the local wood mill for some actual income, or putting up a camping identify ad on the local Craigslist; but unfortunately the lumber isn’t worth enough and there are better spots to camp! My expectations and desire for price appreciation confined the rational and logical questions that needed to be asked. So, when it came to the income aspect of the IDEAL guidelines for a real estate investment, I paid no attention to it. And I paid the price for my hubris. Furthermore, this investment failed to realize the assistance of depreciation as you cannot depreciate land! So, we are zero for two so far, with the IDEAL guideline to real estate investing. All I can do is hope the land appreciates to a point where it can be sold one day. Let’s call it an expensive learning lesson. You too will have these “learning lessons”; just try to have as few of them as possible and you will be better off.
When it comes to making the most of your real estate investments, ALWAYS keep the IDEAL guideline in mind to make certain you are making a good decision and a substantial investment.