Investing In Today’s Real Estate Market:
Investing in real estate is not for everyone. But if you are looking for a way to increase your personal wealth, purchasing a rental property may be for you – especially in today’s real estate market.
We are not talking skyhigh appreciation rates- like the late 1980s or 2004-2006 – which virtually guaranteed a solid return for many real estate investors regardless of what they purchased. What we are talking about is a residential market in which well chosen, well managed rental property of 1-4 units can be the “shining star” in an investor’s portfolio
What’s happenerd? Todays availability of fairley priced – and even some undervalued – homes combined with outstanding low payment interest rates and a solid rental market have boosted sales. Once again, opportunity driven investors are finding a great value, financing the purchase and keeping it rented much easier than in years past.
Keep in mind any opportunity has a downside risk. Real estate is complex and each property is different. But right now experience shows rental property investors can benefit from an informed real estate professional who can find the right property in the right location with the right financing. The key to success today is doing your homework and making sure the numbers work.
If you have bought your own home, you already know many of the financial advantages of real estate ownership. Here is a brief overview of the many ways you can profit from owning rental real estate today
Four Ways Residential Real Estate Investors Build Wealth
Lower Your Taxes
Investor tax incentives can be substanial. Some investors can use deductions from their rental property to offset some of their wage income. Other investors, while not eligible for the offset, can avoid owing taxes on their rental income by showing adequate expenses and deductions. Even if rental payments do not cover the investor’s expenses, tax breaks may actually make up the difference – or more.
As an investor, you can claim deductions for actual costs you incur for financing, manging and operating the rental property. That means mortgage interest payments, real estate taxes, insurance, maintenance, repairs, property mangament fees(if any), travel, advertising and utilities(if the tenant does not pay them) may be subtracted from your adjusted gross income when figuring your personal income taxes up to the amount of the real estate income you receive.
Also, don’t forget deductions for depreciation. The tax code assumes buildings and improvements “wear out” over time. These “losses” are deductible from income, regardless of the property’s actual market value. Depreciation is a non-cash expense; that is, no actual payment needs to be made out of pocket. Although the government collects deferred taxes on the income sheltered by depreciation when you eventually sell, yuo have gotten “free” use of the money in the meantime. And if you do a tax defeered exchange by purchasing a replacement property, you can defer taxes on the depreciation and on any profit. (Ask your tax advisor about Section 1031 on the U.S. Tax Code.)
Have A Positive Cash Flow
A positive cash flow results when the rent you receive exceeds the total you pay for mortgage, taxes, insurance, maintenance and other carying costs.
That’s not as hard as it sounds. First, decide whether you need a positive cash flow before or after taxes. A pre-tax positive cash flow translates into current income, a goal of many retired investors and others with current expenses. Properties yielding a pre-tax positive cash flow are available in today’s market.
If this is your goal, you need to buy wisely. Not all properties will yield high enough rental income to cover expenses. Make sure you know how much rent to expect by finding out about rents for similar uits nearby, the property’s current rental fee and date of last rent increase. Keep in mind you may need to purchase with a large down payment so your mortgage payments are smaller.
A positive after tax cash flow can come from a negative pre-tax cash flow. Generally, the depreciation deduction makes the difference. If you meet the eligibility test, you will be able to use the depreciation to shelter some of your taxable income and reduce your tax bill.
Second, you will want to ensure your tenants make timely rental payments and take care of the property. Of course, a positive cash flow is impossible without rental income. A thorough credit, emploment and landlord check on applicants will help you find good renters and a strong lease combined with a required security deposit will help put you ahead.
As an investor, you magnify the return on your investment by borrowing a large part of the purchase price. That is, by limiting the amount of cash you invest, you make your cash go a long way.
Leverage means using borrowed money to increase equity. And equity – the difference between what the property is worth and the balance owed on the mortgage – is what’s important when figuring whether your dollars are invested wisely.
Assume you bought a $100,000 rental property with a 30% downpayment, and after several years the home is worth $135,000. The $35,000 return on your $30,000 investment is more than 100%. (Several factors will actually lower your profit, but to illustrate the principle of leverage we are keeping the numbers simple.) If you bought that same property with all cash, the return on your investment would be 35%. Leverage puts other people’s money to work for you.
Benefit From Growing Equity
Even at a modest rate of appreciation, real estate may well yield a higher return on the cash investment than some other financial investments, such as bonds or long term CDs. Each mortgage principle payment you make is a payment to yourself. You build equity as your mortgage principle shrinks, even if your investment property does not change in value.
Although homes in different parts of town may appreciate at entirely different rates, the key is shopping carefully for a purchase guided by a knowledgeable professional. Review your expectations about how long you plan to hold onto your investment. When you reach your predetermined “equity Target”, it’s time to sell or refinance – and perhaps use the cash you receive for other investment properties.
Consult A Professional
Your best asset in choosing investment property – whether a rental property or a vacation home – is your real estate professional. A knowledgeable real estate agent can locate prospective properties, provide information and perform a market analysis, investigate local ordinances and regulations, and present your offer to the seller. The agent can assist in finding the best available financing.