They understand the incredible power of real estate. Real estate has the ability to generate passive income and provide a path toward building wealth.
#1 – Cash Flow
One of the biggest advantages real estate creates for earners is passive cash flow. Most of us go through our entire careers focusing on and growing only one stream of income, our active/earned income. Here’s a cash flow example from an active real estate investor:
If you put down $50,000 to buy a rental for $200,000, the mortgage payment would be roughly $1,000 per month. Now let’s say that you’re able to rent it out for $2,000 per month. Upon receipt of the $2,000 monthly rent payment, you pay the $1,000 mortgage, use $700 for expenses and reserves, and keep the remaining $300 as passive cash flow (i.e., money in your pocket).
This is great but what about the busy professional that wants an extra stream of cash flow WITHOUT landlord duties (myself included)?
Enter real estate syndications. These are group investments you can invest in that purchase assets such as apartment complexes. Each one of the units is creating an income stream from the current tenants. They pay rent each month, and that monthly income flows to the owner(s). In this case it’s to the limited partners such as you, me and others without having to become a landlord.
Unfortunately, too many people are only focused on saving for retirement but not cash flow now. The good news is that they’re focused on investing but the bad news is they’re trying to save up enough money so one day they can replace their current income in order to stop working. By choosing this method, they may not ever save enough money to retire and if they do, they then have to worry about running out or being too old to enjoy it. On the flip side, every time you invest in real estate (either physical property or a passive syndication), you develop an extra stream of cash flow which moves you one step closer to your goal of income replacement.
#2 – Leverage
In the example above, you hypothetically bought a $200,000 rental without paying $200,000 in cash. Instead, you put up $50,000 as a down payment, and the bank contributed the remaining $150,000. The cash flow you earned is based on the full $200,000 asset, not the $50,000 portion. 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.
This is the magic of leverage.
Leverage is the use of debt to increase the potential return of an investment. Most of us are familiar with debt. Take buying a car. You can use debt to purchase a vehicle without having to come up with the entire purchase price. This is NOT something I’d recommend but is done more frequently than not. Regarding real estate investing, leverage can be used by taking out a mortgage and only putting down a fraction of the total cost. Even though you only put down a small portion of the purchase price, you are still entitled to ALL of the benefits including:
- the income generated
- build up of equity
- property’s appreciation
- tax benefits
#3 –Equity
If you’re a home owner, then you’re aware that each time a mortgage payment is made, a portion of it goes toward the principal value. This is also true regarding rental property except it’s your tenant that’s paying down the mortgage. In this way, the rental property generates income to pay for itself.
At the end of the mortgage period you’ll own the entire property, and your tenants will have paid for the majority of the cost.
#4 – Appreciation
Real estate values tend to rise over time, which means your money can also work for you in the form of appreciation. From the 1960’s through the early 2000’s there wasn’t a single year of decline in the median home price in the U.S. Appreciation is an important variable which plays a key role in defining the profit from a property for a real estate investor.
Whenever someone is considering investing in apartment complexes, they should pay attention to what improvements are being performed in order to increase the future value. 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 cash flow first and foremost, with appreciation as the “icing on the cake“.
#5 – 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. Depreciation is an accounting method that allows you to deduct the value of an asset over it’s useful life. 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.
If you have any additional questions, please contact us.
