So, you are thinking about investing and have heard people talk about real estate investments, but you are not sure if this is the right option for you.
Investing in the stock market to make money is one way to save for retirement, but there is a whole other world of investing out there that lets you earn money without the fickle moods of Wall Street.
If you are on the fence about real estate investments, read on and find out 5 reasons why real estate is the best way to invest.
The good thing about investing in real estate is the option to get started without needing the capital to fully purchase a property.
This is called leverage. In financial terms it is a method to purchase an asset (a property)with borrowed money, hoping that the after-tax profit will cover the borrowing cost.
Most of us, I assume, don’t have a lot of money saved up in order to start investing in real estate, it is kind of the reason why we, the every-day, full-time working people, consider investing in real estate property in the first place.
So, in order to get started, we can apply for a mortgage and make a downpayment on the property we plan on buying.
This is a great option to get started in the venture of investing, because unlike investing in stocks and bonds, where you would need the capital up front to purchase the shares, with this option you can begin investing and make money while paying off the borrowed portion.
Depending on the financial institution you choose to apply for a mortgage, the percentage of the down payment can be as low as 3.5%, but with a higher down payment sum the amount you would be leveraging your money is at a higher rate.
So, in plain English this means with a larger down payment you can provide, the less money you have to borrow and the less you have to pay back, hence more of the profit will end in your own pockets.
A word of caution about leveraging or borrowing money, always be mindful of the risks you could be facing.
Now, this is where it gets a bit complicated and confusing, but bear with me. Appreciation in the real estate and financial world means an increase in monetary value.
There are two different types of appreciation when it comes to real estate: (1) natural appreciation and (2) forced appreciation.
On average, the natural appreciation rate of a home in the US lies between 3-5%. This also depends heavily on the location of the property, supply and demand, and the state of the housing market.
Forced appreciation means you are actively making improvements on your property to increase the value of it.
Up until now it has been pretty straight forward, but now comes the tricky part: real estate is classified as either residential or commercial.
A residential real estate property includes a single family home or a 1-4-unit property.
A commercial real estate property is a property with 5 units or more.
The difference is important when it comes to evaluating the property. A residential property is appraised on comparable sales. A commercial property is appraised on its net operating income (NOI).
When you want to force appreciation on a residential property your options are sadly limited, but they include improvements to the building (additional bathrooms, increasing the square footage, giving it a good old fashioned facelift).
When forcing appreciation on a commercial property, you have a lot more to choose from, because you increase the net operating income of your investment.
There are many different ways you can add more value to your investment.
For example, you can increase the monthly rent on individual units. You can renovate the units as they become available and in turn increase rent to reflect the property’s value.
You can add amenities that make the property more desirable to potential tenants, like a pool or barbecue area. You can also hire a competent property manager to decrease the available units for rent.
Another way you can increase your net operating income is by reducing expenses. There are plenty of ways a property can be made more energy efficient, which is never a bad idea. There are windows that regulate heat loss and faucets that have a lower flow rate.
3. Cash Flow
Now, let’s talk money in your pockets.
Investing in real estate means cash flow. This is calculated by taking your net operating income and subtracting the mortgage and interest rate payments. Whatever money is left over belongs to you.
Talking money and profit is wonderful, but before you get to that point it is highly advisable and extremely important that you do thorough research into the property and the potential cash flow that can be expected.
Also do mindful research on the type of mortgage you are applying for and ultimately will get, because the greatest cash flow in the world is not going to matter, if the mortgage and interest fees are bleeding you dry.
I know taxes are not everyone’s forte, probably most people would rather hide away than deal with taxes and tax laws and everything that has to do with them.
But, before you skip this section, let me tell you about three different ways the tax laws can actually be on your side and help you save some of your hard earned money.
Depreciation is the decrease in value of a real estate property over time. It is your greatest tax deductible. It reduces the taxable income by the value the property decreases each year.
There are also business expenses you can deduct from your taxes. These can include insurance, mortgage interest payments, maintenance, improvements, advertisement, travel expenses to and from the property etc.
1031 Exchange. Under Section 1031 of the United States Internal Revenue Code, a taxpayer (you) has the option to postpone the acceptance or recognition of any gains or profits by placing the proceeds from one property to another of equal or higher value.
This means that you can upgrade your real estate property without paying any taxes on the sale of it.
Before embarking on taking advantage of the 1031 exchange, familiarize yourself with the many rules and regulations of this option to make sure you qualify and don’t commit any serious error.
5. Portfolio Diversification
In my other article, 9 Steps to get started in the stock market, I talked about the importance of having a diverse investment portfolio by investing in many different stocks and bonds and funds.
Investing in real estate property has the same function. It diversifies your portfolio by giving you another means of earning money that isn’t tied to the stock market. It takes away a risk factor of investing, but gives you another opportunity to save for retirement.
Purchasing real estate is a great option for anyone looking to grow their investments and their wealth and can be an awesome option if you’re trying to expand your money this year.