Why invest in real estate?
Real estate investing can be a lucrative and rewarding enterprise. It can also be a frustrating and profitless exercise. You could write a 1,000 instructional book on all the dos and don’ts of investing, but perhaps the first and most important question to as is simply “Why?” “Why should I invest in real estate and not put my money in savings or stocks?”
The most important benefits of real estate investing are related to the generous return on investment and the ability to control your own destiny. Real estate offers a great way to make significant profits quickly for the self-starters out there. Here is a detailed breakdown of some of these benefits:
- Cash flow – After paying the mortgage and operating expenses, most rental properties will provide cash flow. The amount varies significantly depending on your equity in the building, actual expenses and rent amount. Cash flows of nearly $1,000 a month on a $100,000 building are not unheard of in this current buyers market. I’ll cover this topic in more detail on a future addition of this article series, but in the meantime, you can play around with property numbers yourself with this investment calculator.
- Appreciation – Although the trend has been reversed in the last couple of years, real estate has historically appreciated in value consistently. In step with inflation or better. Unless you refinance your properties, the amount paid in mortgage each year will remain the same, while the value of the property should continually increase over the long-term. In the current buyers market, many of the foreclosures now available are actually priced well below their actual value. In these cases, appreciation can be extremely rapid. Whether its overnight or over-years, this trend will likely continue.
- Loan paydown – Barring a refinance, over time your mortgage will continually be paid down. On 30-year loans it will take many years before you make any significant impact on your loan balance, but on shorter loans such as a 15-year note, the benefits can be noticed more quickly. For example, with a $100,000 loan on a 30-year note at 6%, your monthly payment would be about $600. After fifteen years, you would have paid down $28,951 of the loan balance. You would still have 15 years to go on your loan repayment. On a 15-year note for $100,000 at 5.5% (rates are usually at least .5% lower on 15 year notes that on 30), the monthly payment would be about $817. A decent amount more, but the loan would be totally paid off after fifteen years. And with no mortgage, your cash flow is going to go through the roof. Either way, you’re making money over the long-term.
- Deprecation – With non-owner occupied properties, there are tax benefits not available on your home. Every year, you can claim this deduction for each of your investment properties. The actual amount is determined by subtracting the value of the land the property sits on (generally considered to be 10% of the purchase price for simplicity sake) from the purchase price of the property. Then you divide the number by 27.5 for residential properties or 39 for commercial properties. This amount can be claimed annually as a tax deduction. This deduction does technically have to be repaid when you sell your properties, but there are various sheltering methods such as a 1031 Exchange, which can indefinitely defer repayment.
- Rate of return – Unless you really play your cards right, the rate of return for your investment dollar in real estate is almost impossible to match. When you get $550 in rent per unit at your new 4-family bought for $140,000, there is no doubt that the cash flow is going to be pretty solid. When you compare how much money you are making compared to how much you actually invested, the numbers can be staggering. Using realistic expenses for this fictional example, with 25% down on this property ($35,000), you would have a monthly cash flow around $890. That’s $10,680 a year. Comparing the two, that is a 31% annual return on your investment. What stock can match that?
- Control your own fate – If you make wise purchases, properly insure your properties, and screen your tenants well, things should go smoothly in your investing career. In most forms of investment, you simply control when you put money in and when you take money out. With real estate, you not only control these aspects, but you control the actual fate of the investment as well. Rather than being beholden to some faceless board of directors, you control your money. Whether you handle all aspects of leasing, management and maintenance yourself, or sub those tasks out, you always call the shots.
Obviously, this breakdown has been very simplified. There are other expenses and considerations to take into account while investing in real estate, to be certain. Regardless, considering all the ways in which you can profit from real estate investing, there is no doubt that there is money to be made. If you are convinced that real estate investing is a winning situation then you must consider the next issue. Potential profits aside, investing isn’t for everyone. It takes a certain type of person. In the next article in this series, we will ask: Who should invest in real estate?