The Major Pros of Investing in Real Estate
You may be wondering, why should I purchase or invest in real estate in the first place? This is the best investment possible. First, let’s discuss why somebody would want to own investment property. To simplify things, let’s just use an established acronym that describes the most important advantages of all types of investment property. To put it simply, commercial real estate is the BEST kind of investment. The acronym IDEAL means:
Two key terms: • I – Income • D – Depreciation
E for Expenses; A for Appreciation; L for Leverage.
When compared to other possible investments, real estate is the best option. All the advantages will be discussed in detail.
IDEAL’s “I” represents “Income” in its acronym. (also known as a cash flow surplus) Does it make money at all? Monthly rent payments from tenants should be bringing in money for your investment property. Although there may be some empty months, your investment should be generating revenue for the most part. You should exercise caution since inexperienced investors sometimes make inflated assumptions and fail to account for all expenses. Before making a purchase, the investor has to understand that the property will have monthly expenses (otherwise known as negative cash flow). We will talk about the precise circumstances when this situation is acceptable rather than disastrous. In the end, it comes down to the investor’s willingness and capacity to bear the financial burden of a non-productive asset. Many residential real estate investment properties saw their values soar throughout the boom years, while their rents remained relatively stable. Many naive investors bought homes without realizing the high monthly payment would be severely impacted by the large principal on the mortgage. Recognize this and try to plan for a positive cash flow situation so that you can achieve the INCOME portion of the IDEAL equation.
For the mortgage payment to be manageable each month, a larger down payment (and hence a smaller mortgage amount) may be necessary. In a perfect world, you would be able to pay off your mortgage and have a steady stream of income month after month. This is something that should play a significant role in one’s retirement strategy. The goal, and the payoff for incurring the risk of buying investment property, is to repeat this process many times so that you never have to worry about money again.
Depreciation is symbolized by the “D” in IDEAL. Depreciation from investment property may be written off against other taxable income. So, what exactly is depreciation? It’s a way of calculating the entire cost of real estate investment that doesn’t include costs. With another light, the moment you drive off the lot in your brand-new automobile, its value begins to drop. The Internal Revenue Service (IRS) permits you to deduct the annual cost of maintaining your investment property from your taxable income. For the avoidance of doubt, I am not a tax expert, and what follows should not be taken as tax instruction or advice.
Accordingly, the rate of depreciation on an investment property in the real estate market depends on both the property’s initial purchase price and the number of years it has been on the market (recovery period based on the property type-either residential or commercial). If you have ever received a tax assessment on your home, you know that it is often divided into two parts: the land value and the building value. Your entire “basis” for property taxes is the sum of these two figures. The initial base value of the building is all that may be deducted for tax purposes as depreciation; the land itself cannot be depreciated (because land is typically only APPRECIATING). The property’s value declines every year as its effective age increases, much as a brand-new automobile does when its owner drives it off the lot. The tax code even allows you to take advantage of this!
One practical application of this idea is depreciation, which may be used to offset taxable income or even indicate a loss when dealing with the Internal Revenue Service. Also, you may exclude that (paper) loss from your income when filing your taxes. Thus, it’s very helpful for those who are seeking a “tax-shelter” for their property investments.
Assume, without getting too technical, that you have a $500,000 residential investment property and can deduct $15,000 each year from it. Assuming that the rental revenue from this property brings in $1,000 each month after costs, you would have a total of $12,000 in income for the year. If you owe any income taxes, you may deduct $3,000 from this sum by showing that your investment property depreciated in value by that amount ($12,000 minus $3,000). After the “cost” of the $15,000 depreciation amount was considered, the IRS determined that this property had a loss of $3,000. While you won’t have to pay taxes on your rental income, you may offset your other taxable income, such as that from your day job, by using the $3,000 paper loss you’ll have incurred. Properties with greater prices also tend to provide more of a tax shelter. Benefiting from depreciation with their underlying real estate investment, investors utilize this to reduce their annual taxable liability.
Even though this is a major perk of owning investment property, few people are aware of it. As mentioned above, this explanation of depreciation was meant to be brief as the topic of taxes is somewhat complex. Make sure you consult a tax expert who can provide you sound advice on tax and depreciation concerns so you know where you stand.
Costs are emphasized as the IDEAL’s “E.” All costs made by the property and directly related to the investment are generally tax deductible. All of your monthly bills, including utilities, insurance, mortgage, interest, and taxes. Everything you spend on a property management or on maintenance and upkeep is tax deductible. Investing in real estate entails a plethora of outlays, obligations, and responsibilities meant to maximize the return on the property’s investment value. Therefore, all of these costs are normally deductible by the owner of investment real estate under current tax legislation. If you ever incur a loss on a business investment or investment property, or if you take a loss on purpose, you may deduct the loss (cost) from your taxable income in subsequent years. To others, this may seem like a very technical and aggressive move. It’s another another possible upside to buying real estate for investment purposes.
For example: “A” in “IDEAL” stands for “Appreciation.” The term “appreciation” refers to the increase in value of an investment over time. It’s a potent tool for expanding your financial standing, which is one of the primary reasons why we invest. These days, a house in San Francisco might cost several million dollars, but in the 1960s, it was probably worth less than the automobile you were driving then. Real estate prices in the city have increased tremendously over the last several decades as a result of the area’s increasing popularity and the resulting high demand. Lucky homeowners who knew this or who happened to be in the right spot at the right time and decided to stay there have seen returns on their homes in the thousands. That right there is what it means to show gratitude. Where else can you get such a high return on such a low risk investment? The nicest aspect about investment real estate is that you can have someone else pay you to live in it while they pay down your mortgage and generate revenue (positive cash flow) for you every month.
Leverage, represented by the letter “L” in IDEAL, is often known as “other people’s money” (OPM). One example is when one spends a very little sum to acquire complete control over a very costly item. When you take out a loan to pay for a down payment, you are effectively leveraging your money to acquire an item you could not afford otherwise. When compared to the stock market, real estate is a more safer and more forgiving environment for the use of leverage (where this is done through means of options or buying “on Margin”). The real estate market often uses leverage. People would only make real estate purchases if they had access to the whole amount needed to pay for the purchase out of pocket. As our recovery continues, more than a third of all transactions are being conducted with cash. Still, around two-thirds of all transactions include some kind of finance, suggesting that the vast majority of purchasers in the market value the leverage offered by financial instruments such as mortgages and loans when purchasing investment property.
When an investor puts down 10% on a $100,000 home and borrows the rest 90% through a mortgage, they are “leveraging” the remaining 90%. Assume that over the course of the following year, the local real estate market experiences a 20% increase, increasing the property’s value to $120,000. Looking at it through the lens of leverage, the value of this property rose by 20%. This 20% appreciation in property value may not seem like much, but when compared to the investor’s $10,000 down payment (the “skin in the game”), it doubles the investor’s return on the investment actually made, often known as the “cash on cash” return. As a result of the addition of this $10,000, the total value and potential profit have both increased by $20,000, or 200%.
Although it’s true that using leverage may have its advantages, like any other good thing, it’s possible to use too much of it. Many investors were over-leveraged in 2007 when the real estate market crashed. There was no way for them to survive the economy’s correction. Being at the mercy and whims of the general market changes is avoided in favor of making prudent investment selections that allow you to buy, keep, pay off debt, and expand your money. As history would predict, there will inevitably be subsequent booms and busts as we go farther into the future. To avoid being pounded and wounded by the side effects of whatever market we find ourselves in, more planning and preparation when developing net worth is essential.
Investment real estate is for more than just income flow and gain, despite what many believe. As was just discussed, there are several upsides associated with buying investment property. The trick is to get the most out of your money.
Moreover, the IDEAL acronym is not only here to serve as a reminder of the advantages of investment real estate, but also as a guide for each and every investment property you will consider acquiring in the future. You should ensure that the property you buy meets all the criteria outlined by the IDEAL acronym. The property under consideration must have valid reasons for deviating from the standards. If an investment you’re thinking about doesn’t meet these criteria, you should probably NOT make it.
Here’s a personal example of a house I bought when I first started out in the industry. It was the worst investment decision I ever made, and it was all your fault for not following the IDEAL principles you’re learning about here. My understanding was limited, and my naiveté was obvious. There was an empty lot in a gated neighborhood that I bought. HOA (monthly maintenance charge) was already in place due to the property’s good amenity facilities that were constructed for it in preparation of future house construction. The market had been expected to rise in value over time, but things took a turn for the worst just before the Great Recession of 2007-2012. Have you seen any major flaws in my implementation of the IDEAL criteria?
First, I’d want to say. Income was lost on the empty land. If the offer is too good to pass up, this could be okay. Nonetheless, the transaction itself was somewhat unremarkable. Honestly, I’ve thought of selling the trees on the empty lot to the local wood mill for some genuine revenue, or putting up a camping site ad on the nearby Craigslist; but, the timber isn’t worth enough, and there are nicer places to camp! My hope for a profit prevented me from asking the necessary, reasonable inquiries. For this reason, I ignored the IDEAL standards’ emphasis on generating revenue from real estate investments. My arrogance cost me dearly. Since land is not subject to depreciation, this investment never got its money’s worth through depreciation. So far, our attempts to follow the IDEAL guideline for property investment have failed miserably. Nothing I can do except wait for the land to increase in value enough to sell it. To put it simply, that was a very costly lesson. You, too, will experience these “learning lessons;” to thrive, minimize their frequency as much as feasible.
You should ALWAYS have the IDEAL guideline in mind to make sure you are making a wise selection and a great investment when it comes to real estate.