By Joe Firmin 4-Minute Read
The vast majority of us spend our lives working full-time jobs to earn a “steady” paycheck. This security is what we were told we needed growing up, it’s addicting and then necessary – all at different stages of life. Meanwhile, the wealthy have unlocked the code to working less while making their money work for them.
So, what is it that the wealthy know that the rest of us don’t?
One of the biggest secrets that the wealthy tap into is the incredible power of real estate. Real estate has the ability to generate passive income and provide a path toward building wealth. Every dollar invested in real estate is IDEAL, because it works for you in these five ways:
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Income
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Depreciation (Tax benefits)
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Equity
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Appreciation
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Leverage
#1 – Income
The greatest benefit of investing in real estate is income cash flow. When an asset is purchased and rent is collected from tenants, the remaining value, after property expenses are paid, is your cash flow.
If you put down $50,000 to buy a rental for $200,000, your mortgage payment would be about $1,000 per month. Now let’s say that you’re able to rent the unit out for $2,000 per month.
Upon receipt of the $2,000 rent payment each month, you pay the $1,000 mortgage, use $700 for expenses and reserves, and keep the remaining $300 as income cash flow (i.e., money in your pocket – a/k/a mailbox money).
#2 – Depreciation (one of the Tax Benefits)
When you invest in real estate, you get the benefits of depreciation and mortgage interest deductions, as well as a whole host of write-offs for a number of other related expenses.
Investors often show losses on paper, while actually making money through cash flow. The losses play a big part in helping to offset other income, which is a major reason real estate is so lucrative.
Further, when investing in commercial real estate syndications, you have the opportunity to take advantage of cost segregation and accelerated depreciation, further increasing your tax benefits. Stay tuned for another post about those two gems.
#3 – Equity
As you receive monthly rental checks and use them to pay the mortgage, your equity in the property increases. In this way, the rental property generates income to pay for itself.
Imagine buying a laptop that generated money to pay for its own WIFI!
Once your rental builds significant equity, you may have the opportunity to use a home equity line of credit (HELOC), which allows you to borrow against your existing asset. HELOC funds can be invested into another asset, which allows you to make your money work even harder for you.
#4 – Appreciation
Real estate values tend to rise over time, which means your money can also work for you in the form of appreciation.
For example, consider a property purchased for $580,000. In time, the duplex appreciates to $750,000, at which point it is sold. The profit at the sale, or $170,000, will have been generated via appreciation, plus any additional equity that you had built through paying down the mortgage.
That being said, while appreciation is nice, it’s not guaranteed, which is why you should always invest for income cash flow first and foremost, with appreciation as the icing on the cake.
#5 – Leverage
In the first example we discussed, you had hypothetically bought a $200,000 rental without paying $200,000 in cash. Instead, you put in $50,000 as a down payment, and the bank contributed the remaining $150,000.
The cash flow return you earn is based on the full $200,000 asset, not the $50,000 portion. This is the magic of leverage. If you paid ALL cash for the rental your return would be ($300*12) / $200,000 = 1.8% return on your cash. Because you put down only $50,000, your return is actually ($300*12) / $50,000 = 7.2% - Now that’s more like it! Thanks Bank!
Even though the bank contributed 75% of the money, all you have to do is pay the mortgage and interest, and any excess cash flow or profit is all yours to keep. No need to share it with the bank.
Advantages of Investing in Real Estate
With each dollar invested in real estate, you have the opportunity to take advantage of Income, Depreciation (tax benefits), Equity, Appreciation and Leverage. This is true regardless of whether you invest in single-family rentals, large syndications, or anything in between.
If you’d like to discuss with me, I’d be happy to jump on a call with you. Schedule a call HERE.
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