So... You may think about, why should you buy or put money into real estate in the First Place? Because it is the IDEAL investment! Let us take a moment to address exactly why people should have investment real-estate in the first place. The easiest answer is a well-known acronym that addresses the key benefits for all investment real estate. Put simply, Investment Real Estate is an IDEAL investment. The perfect stands for:
• I - Income
• D - Depreciation
• E - Expenses
• A - Appreciation
• L - Leverage
Real-estate is the IDEAL investment compared to all others. I'll explain each benefit detailed.
The "I" in IDEAL stands for Income. (a.k.a. positive income) Does it even earn cash? Your investment property needs to be generating income from rents received every month. Of course, there will be months in places you may experience a vacancy, as well as the most part your investment will likely be producing an income. Take care because many times beginning investors exaggerate their assumptions and take into account all potential costs. The investor should be aware of going into the purchase that this property will COST money monthly (otherwise known as negative cash flow). This scenario, although not ideal, may be OK, only in specific instances that we'll discuss later. It amounts to the risk tolerance and talent for the owner to fund and pay for a bad producing asset. In the boom years of real estate property, prices were sky high and the rents didn't increase proportionately with lots of residential real estate investment properties. Many naïve investors purchased properties using the assumption that the appreciation in prices would a lot more than compensate for the fact that the high balance mortgage has to be significant negative affect the funds monthly. Be aware of this and do your best to forecast an optimistic cash flow scenario, to be able to actually realize the INCOME part of the IDEAL equation.
In many cases, it may require a higher advance payment (therefore lesser amount being mortgaged) so your cash flow is acceptable monthly. Ideally, you eventually pay off the mortgage so there is not any question that cashflow will be coming in monthly, and substantially so. This ought to be a vital component to one's retirement plan. Make this happen a few times and you won't have to worry about money at a later date down the road, which is the main goal as well as the reward when deciding to take the risk in purchasing investment property initially.
The "D" in IDEAL Represents Depreciation. With investment property, you are able to utilize its depreciation on your own tax benefit. What's depreciation anyway? It's a non-cost accounting method to consider the overall financial burden incurred through real estate investment. Look at this another way, when you buy a brand new car, when you drive off the lot, that car has depreciated in value. In terms of your investment real estate property, the IRS allows you to deduct this amount yearly upon your taxes. Please note: I am not a tax professional, so this is not meant to be a lesson in taxation policy or be construed as tax advice.
With that said, the depreciation of your real estate investment property is based on the overall value of the dwelling of the property as well as the length of time (recovery period based on the property type-either residential or commercial). If you have ever gotten a property goverment tax bill, they usually break your property's assessed value into two classes: one for the value of the land, and yet another for the value of the framework. Both of these values added up equals your total "basis" for property taxation. With regards to depreciation, you can deduct with regards to your taxes on the original base price of the structure only; the IRS doesn't allow you to depreciate land value (because land is typically only APPRECIATING). Just like your new car driving off the lot, it's the structure about the property that is getting less valuable every year since it's effective age ages and older. And you may use this to your tax advantage.
The best example of the benefit with this concept is through depreciation, it is possible to turn a property that can cause a positive cash flow into one which shows a loss (in writing) when dealing with taxes and also the IRS. And by the process, that (paper) loss is deductible against your income for tax purposes. Therefore, it's actually a great benefit for people that are specially looking for a "tax-shelter" of sorts for real estate investments.
For instance, and without getting too technical, think that you are able to depreciate $15,000 per year from a $500,000 residential investment property that you simply own. Let's say that you are cash-flowing $1,000 a month (and thus after all expenses, you happen to be net-positive $1000 each month), so you have $12,000 total annual income for the year from this property's rental income. Even though you took in $12,000, you can show through your accountancy using the depreciation of the investment real-estate that you actually lost $3,000 written, which is used against any income taxes that you may owe. In the standpoint of IRS, this property realized a reduction of $3,000 after the "expense" of the $15,000 depreciation amount was taken into account. Not only are there no taxes due on that rental income, you can utilize the paper loss in $3,000 against your other regular taxable income out of your day-job. Investment property at higher price points will have proportionally higher tax-shelter qualities. Investors make use of this to their benefit in succeeding as able to deduct all the against their taxable amount owed each year through the benefit for depreciation with their underlying real estate investment.
Although this is a vastly important profit to owning investment real estate, the subject is not well understood. Because depreciation is really a somewhat complicated tax subject, the above mentioned explanation was meant to be cursory in nature. In relation to issues involving taxes and depreciation, be sure to have a tax professional that will advise you appropriately so that you know where you stand.
The "E" in IDEAL is made for Expenses - Generally, all expenses incurred amongst the property are deductible with regards to your investment property. The price for utilities, the charge for insurance, the mortgage, and the interest and property taxes you have to pay. If you use a property manager or maybe if you're repairing or enhancing the property itself, all this is deductible. Real estate investment comes with a lot of expenses, duties, and responsibilities to be sure the investment property itself performs towards the highest capability. Because of this, contemporary tax law generally allows that of these related expenses are deductible to the benefit of the investment real estate landowner. If you were to ever take a loss, or purposefully took a reduction on a business investment or investment property, that loss (expense) can carry over for multiple years with regards to your income taxes. For some people, this is an aggressive and technical strategy. Yet it is another potential benefit of investment real estate.
The "A" in IDEAL is for Appreciation - Appreciation means the development of value of the underlying investment. It's one of the main reasons that we put money into the first place, and it's a powerful way to grow your net worth. Many homes from the city of San Francisco are several million dollars these days, but back in the 1960s, exactly the same property was worth concerning the cost of the car you're currently driving (probably less!). Throughout the years, the area became widely used and the demand that ensued caused real estate prices in the city to develop exponentially compared to where these were a few decades ago. Folks that were lucky enough to recognize this, or have been just in the right place at the right time and continued to exist in their home have realized a great investment return in the A huge number of percent. Now that's what appreciation is all about. What other investment can make you this kind of return without drastically increased risk? The best part about investment real estate property is that someone is paying that you live in your property, paying off your mortgage, and creating earnings (positive cash flow) for your requirements each month along the way throughout your course of ownership.
The "L" in IDEAL stands for Leverage - A lot of people refer to this as "OPM" (other people's money). This is when you are using a small amount of your cash to control a much more expensive asset. You happen to be essentially leveraging your advance payment and gaining charge of an asset that you would normally struggle to purchase without the loan itself. Leverage is much more acceptable in the real-estate world and inherently less risky than leverage in the stock world (where this is accomplished through means of options or buying "on Margin"). Leverage is normal in real estate. Otherwise, people would only buy property after they had 100% of the cash to do so. Over a third of most purchase transactions are all-cash transactions as our recovery continues. Still, about 2/3 coming from all purchases are done with some degree of financing, so the most of buyers in the market take advantage of the power that leverage can offer when it comes to investment real estate property.
For example, if a property investor was to obtain a house that costs $100,000 with 10% down payment, they are leveraging the remaining 90% through the use of the associated mortgage. Suppose the local market improves by 20% over the next year, and therefore the actual property owner now worth $120,000. With regards to leverage, from the standpoint of the property, its value increased by 20%. But compared to the investor's actual deposit (the "skin in the game") of $10,000- this surge in property value of 20% really means the investor doubled their return about the investment actually made-also called the "cash on cash" return. In this case, that is 200%-because the $10,000 is currently responsible and eligible for a $20,000 rise in overall value and also the overall potential profit.
Although leverage is recognized as a benefit, like the rest, there can always be too much of a good thing. In 2007, once the real estate market took a turn to the worst, many investors were over-leveraged and fared the worst. They could not weather the storm of your correcting economy. Exercising caution with every investment made will assist you to ensure that you can purchase, retain, pay-off debt, and grow your wealth from your investment decisions made as opposed to being at the mercy and whim of the overall market fluctuations. Surely you will see future booms and busts as the past would dictate even as we continue to move forward. More planning and preparing while building value will help prevent getting bruised and battered through the side effects of whatever market find ourselves in.
Many people believe investment real estate is just about cash flow and appreciation, however it is so much more than that. As pointed out, you can realize several advantages through each real estate investment property you purchase. Task is to maximize the benefits through every investment.
Furthermore, the best acronym is not just a reminder of the benefits of investment property; it's also here to provide as a guide for every investment property you will consider purchasing in the foreseeable future. Any property you buy should conform to every one of the letters that represent the IDEAL acronym. The underlying property must have a good reason for not fitting all the guidelines. And in nearly every case, if there is a great investment you are considering that doesn't hit all the guidelines, by most accounts you should probably PASS on it!
For instance a story of my own, regarding a property that we purchased early on inside my real estate career. Even today, it's the biggest investment mistake that I've made, and it's really precisely because I didn't stick to the IDEAL guidelines you are reading and researching now. I was naïve and my experience was not yet fully developed. The home I purchased was a vacant lot in the gated community development. The property already had an HOA (a month-to-month maintenance fee) due to nice amenity facilities which are built for it, as well as in anticipation of would-be-built homes. There were high expectations in the future appreciation potential-but then the market turned for that worse as we headed to the great recession that lasted from 2007-2012. Could you see what parts of the IDEAL guidelines I missed on completely?
Let's move on with "I". The vacant lot made no income! Sometimes this can be acceptable, if the deal is one area that cannot be missed. And also for the most part this deal was nothing special. In all honesty, I've considered selling the trees which can be currently on the vacant lot for the local wood mill for some actual income, or setting up a camping spot ad about the local Craigslist; but unfortunately the lumber isn't worth enough and there are better spots to camp! My expectations and require for price appreciation blocked the rational and logical questions that must be asked. So, when it came to the income aspect of the IDEAL guidelines for a real estate investment, I paid no care about it. And I paid the price of my hubris. Furthermore, this investment failed to realize the benefit of depreciation because you cannot depreciate land! So, we have been zero for two to date, with the IDEAL guideline to real estate investing. All I can do is hope the land appreciates to a degree where it can be sold one day. Let's call it a costly learning lesson. You will have these "learning lessons"; just try to have as few of them as possible and are better off.