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WHY INVESTMENT REAL ESTATE
I know you have all seen the late night infomercials on television. Some of what they say is true, a lot of it is a lot of high hopes and low reality. So when I say that you may want to consider adding real estate to your investments, you may say: "Just another hype salesman trying to get his hands into my pockets".
I will admit, getting paid is an appealing concept. However, I am more than willing to earn that commission. If what I say makes sense, and more important, makes you money, then perhaps I may be worth it.
Everyone has to live somewhere. Although home ownership is the American dream, many fail to follow up on this dream. Instead they do buy a home and perhaps several in their lifetimes. If they fail to buy for themselves, then they by their actions, purchase properties for their landlords. The Government realizes they have a responsibility to provide housing, and so the tax codes favor the landlord who provides housing for others. If the landlords do it, the government does not have to step in and do it.
Since the tax code modifications in 1989, the profitability of rental units has been shifted more towards the tenants and away from tax loopholes. However, even now, many investment properties do supply a safe harbor for profits and the reduction of taxes to their investors.
The numbers are the numbers. This is true to a point. The hidden cost of repairs and to bring a property up in condition to demand higher rents are also a major factors that should not be over looked. A prudent investor looks at the property in it's present condition. Looks at those repairs to be expected. Then checks the market to see if the property could be improved and if these improvements would then command higher rents and higher profit margins. Each property is unique and must be analyzed on it's own merits.
We have been talking about profits and taxes in general terms. Let us now get specific. In short, the return on a piece of property comes from four factors.
1) GROSS OPERATING INCOME - Simply put, income is the difference between the rents paid to you, minus an allowance for vacancy less the mortgage payments, taxes, utilities, insurance, advertising, repairs, garbage etc. equals what is left or your income each year. This is all scheduled out ahead of time on each property you are considering. Then you purchase the one that makes the most sense for your investment needs. This may not be the one that makes the most money. It may in fact be the one that makes something in the middle but has the least invested time for you. It all depends on your needs, long term plans and investment style.
2) PRINCIPLE REDUCTION - Any time you get a mortgage on a property you have to make payments at a specified interest rate for a number of payments over a specific period of time. Every time you make one of these payments, interest is paid for the use of the money for the preceding month and a small amount removed from your principle balance. Each month and each year you pay off a piece of the property. Over time this increases your equity to the entire amount borrowed from the bank. With each payment, the interest payment becomes less and the principle reduction increases. The interest is a deduction to your income taxes and the principle reduction is money you make off the property each year, complements of your tenants.
3) TAX SAVINGS - Some or all of the money you make from a property can be sheltered or tax deferred. You may even be able to reduce taxes you pay from other income. The government allows you to depreciate the building, personal property, landscape and parking lots at various rates. By structuring your offer, you can legally create enough depreciation that when added to the interest and operating expenses; that you can reduce or avoid income taxes.
4) APPRECIATION - A smart investor does his numbers without appreciation. In other words, running the building and paying expenses is done without considering long term increases in the building's value. All real estate does go up over time and this increase is called appreciation. The good news, is that this increase is not taxes until sale and there are ways to avoid ever paying taxes on this increase. Things like tax free exchanges.
When you add these factors together, you will often see a return of over 20% per year without appreciation on the investor's initial out of pocket investment. With the banks paying 2 to 5% and other investments subject to their up's and downs, real estate may look like a solid alternative. Best of all, the tenant's pay all the bills and even your income taxes to give you these high returns on your investment.
Are there risks? Yes there are. Poor tenant selection can cause a lot of damage, time consuming evictions and lost rents. Milking a property and letting the repairs go can eventually lead you into a situation where cosmetic expenses may be replaced by structural expenses. Most problems are created by the owner. If you do your research right and put together good numbers on the income and expenses of the property, you will normally make out quite well. Greedy landlords end up costing themselves in the long run. There are no free rides, no get rich quick without effort, and no magic investments. Real Estate is a solid investment for solid investors.
Being a landlord is not for everyone. It helps, but is not mandatory to be handy. More important is tenant selection and building upkeep. It takes a commitment of time and some money to make being a landlord practical.
If you are interested in learning more, give me a call and we can sit down and go into your needs and investing in more depth.
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