| How to Profit from Real Estate |
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Most of us are familiar with the mainstream, conventional investing avenues tied to the stock market. Pick up any financial magazine and you’ll likely find it filled with advertisements from mutual fund and brokerage companies. Television networks and internet news organizations also tend to focus on the financial markets and talk about the price trends in key stock indexes such as the Dow, Nasdaq and S&P. We rarely hear these mainstream media sources talk substantively about real estate as an investment. At HausAngeles real estate is our focus. It’s our passion, we understand its power and its intricacies, and it’s how we help people build wealth. While securities basically offer two ways to get paid (dividends/cash flow and capital gains), real estate offers four basic ways to make money: Cash Flow, Debt Pay down, Depreciation & Tax Benefits, and Price Appreciation.
Cash Flow: These are the magic words many use to determine whether a real estate deal is worthy. Simply put, cash flow is all the income you collect from a given property minus all of the expenses (including debt service costs) associated with that property. It’s the money that goes in your pocket to be spent or reinvested. But, the cash flow dollar amount doesn’t tell the whole story about the quality of a real estate investment. Instead, the cash flow figure should be used to determine a “percentage return” on your initial investment amount. This is referred to as Cash on Cash Return.
Debt Pay down or Principal Reduction: Now that “interest only” loans seem to be a thing of the past, investors and home buyers must re-familiarize themselves with amortizing loans. An amortizing loan includes both principal and interest payments each month and typically results in a reduction of principal owed down to zero once the loan is fully paid off (i.e., at the end of the amortization period which is typically 15 or 30 years). While the loan payment amount usually stays the same month after month, each consecutive payment includes less interest and more principal. Here is your profit! Most real estate loans help pay down the principal by 1 to 2 percent in the first year. Because of the leverage provided by the loan, that 1-2% of debt pay down can actually equal a return on your initial investment of up to 10%. In other words, tenants can provide cash flow and also help pay down your debt.
Depreciation and Tax Benefits: The value of depreciation, tax deferred earnings and the time value of money are the third way investors can profit from real estate. Depreciation is sometimes called the IRS’s gift to real estate investors by savvy investors. No other investment avenue that we know of gets the benefit of depreciating in value for tax purposes while generally appreciating in the real world. The IRS allows you to take a percentage of the “improved value” of your property as a tax loss each year. In California, for a one million dollar property as an example, depreciation could result in a tax benefit of approximately $15,000 – 25,000 each year. These taxes are deferred until the property is sold; if there is no 1031 exchange at that time. In addition to depreciation, virtually every dollar you spend on your property is typically tax deductible. This list of tax deductible expenses can include insurance, taxes, maintenance, mortgage interest and even travel to/from your property. In many situations this tax treatment results in rental income that is completely tax deferred, which can be valuable for many investors.
Price Appreciation: This is the big one! On average during the 20th century, real estate home values on a national level appreciated approximately 4% annually. Given real estate is a cyclical industry, those that bought and sold at opportune times in the cycle realized even better returns. But you may ask: If I can make 8% in the stock market, then why settle for 5% in real estate? The answer is the power of leverage! If you purchase a property with 20% down and finance 80%, then a 5% increase in value really equates to a 25% increase on your initial investment! You’ll get the full benefit of appreciation on the entire value of the property, while only using 20% of your own money to buy it. These are 4 of the most common ways to profit from investment real estate. In future articles we’ll discuss other ways, like buying with “Built –In Equity” or Creating “Instant Equity”. Give us a call to talk about how you might grow your wealth through investment real estate. It may be easier to start than you think. If you are already an investor, you may be surprised at some of the opportunities available these days.
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