Ways that Investing in Real Estate Works for You

Dated: June 15 2022

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6 Ways Real Estate Investments Can Work for You

 

Buying and leasing residential real estate is a dynamic financial investment. Sometimes a real estate investment is relegated to how much the house costs per month, less than what you make in rent. But, it is so much more than that!

 

There are six ways a real estate investment works for you financially, and I have explained them below. 

 

1.)  Cash Flow

Does the property make more than it costs each month? Hopefully, it does because this is the most known way real estate works for investors financially.

 

No matter the strategy, real estate investment is not a get-rich-quick investment tool. It is a long-term investment that incrementally makes financial progress in different ways. In terms of cash flow, the difference between how much the property costs the owner every month and how much money it brings in is considered your monthly net profit. Some investments will yield significant percentages of cash, and some relatively nominal. A positive cash flow is most important when evaluating a real estate deal. This is especially true if an investor wants to offer a mortgage on the property because lenders will look at the business case of the real estate, and they focus primarily on how well the property performs from a cash flow perspective. 

 

2.)  Real Estate Appreciation

What if you think about real estate as a retirement investment. If you put money in a retirement investment tool like a 401K, the money can grow over time. The same is true about real estate investing. The money you invest or spend on purchasing real estate should grow over time through real estate appreciation. 

 

Based on the fundamental economic principle of supply and demand, land supply does not increase in the same way the human population increases. This fact insinuates that the supply of homes will not grow at the same rate as the demand for housing, leading to price appreciation. This real estate appreciation is a function of building equity, or the net of the market value of your property (what you can sell it for) and what debts you have on the property (a mortgage). This equity ultimately contributes to your net worth but doesn't translate directly into money in your account. 

 

Historically, residential real estate in the United States has appreciated steadily for many decades. Of course, there are ups and downs over time, but real estate trends are up. The critical factor in property appreciation is the time you own it! The more time you own real estate, the more it will appreciate. This is true if you adequately maintain the real estate to ensure proper relative market value versus other comparable properties in the surrounding areas. 

 

3.)  Tenants pay down principal and interest.

A residential real estate tenant pays rent to the property owner. The debt is likely amortized if the owner has a mortgage on the property. Amortization spreads the cost of interest throughout an extended period (10, 20, or 30 years typically), and the tenant rent ultimately pays down the principal balance of the debt and pays for the cost of using the debt (the interest). 

 

How great does this sound? For example, you own a house; you rent the home to a tenant who pays you monthly rent. Some of the rent pays down your principal, some pays the interest, and some is left over for you while you own the property. 

 

4.)  A tool to diversify your income and hedge against inflation

I don't know too many people whose only job is real estate investing. Most people have a job that brings in most of their household income. Real estate investment serves as a secondary income stream that helps ease the burden of regular expenses while also working to grow wealth that is not directly related to your 9 to 5 job. 

 

Real estate has historically been a reliable tool to hedge against inflation. (We are experiencing rapid inflation now, but this will likely be a slight ebb to the normal flow of inflation and real estate appreciation norms.) For example, suppose inflation over the last decade has been about 2% yearly, and real estate price appreciation has ranged between 5-11% annually. In that case, real estate appreciation offsets inflation's negative impact. 

 

5.)  Tax benefits

There are many potential tax advantages offered to real estate investors. Often a real estate portfolio will operate with a substantial profit, but the owner may pay very little in taxes. This is due to real estate investor tax write-offs offered by the IRS. 

 

Real estate tax write-offs include countless items such as:

  • Operating expenses and maintenance
  • Property management fees
  • Owner paid utility expenses
  • Owner association dues
  • Legal and professional fees
  • Insurance and property tax
  • Mortgage interest deductions
  • Travel expenses to visit an out-of-town property

 

The IRS also allows investors to depreciate the asset over a defined period. Real estate depreciation means an investor can spread the expense of the overall property over time and add it to a property's operating costs. This can reduce the taxable income and the amount of taxes the owner pays. 

 

6.)  Self-funding

Another long-term benefit of real estate investing is the tool of self-funding real estate deals. Over time, investors build up equity in one or multiple properties that can be leveraged to buy additional properties. Ultimately, this allows an investor to use the amount of equity gained over time to purchase real estate instead of investing other liquid assets into a property acquisition. 

 

When an investor achieves this status, they can be more nimble in what they acquire and the speed at which they can acquire it. In addition, this often allows investors to circumvent the bank's underwriting of one specific transaction, which can slow or even stop the investor's plan to purchase the property. 

 

Leveraging existing equity is often much cheaper over time than issuing a mortgage on a new piece of property or typing up liquid assets like additional cash in a real estate transaction that is not liquid. 

 

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There are so many ways to grow wealth by investing in real estate. I make it my business to talk with whoever wants to learn more about strategically investing in real estate to meet their goals. So if you or someone you know would like to talk about real estate investment, let me know!

 

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