A number of our agents (including Robyn) are real estate investors and therefore truly enjoy working with other investors in buying investment properties. After all, this new real estate landscape is quickly creating a landlord’s market. When money is tight, many buyers are unable to qualify for loans and must therefore rent single family homes, rather than purchasing single family homes. I believe that Real Estate is a great investment for so many reasons. It is one of the few investments that allows you to:
- Buy an appreciating, high value asset for a percentage of its market value. This is otherwise known as your down-payment, which is typically 5% – 20%.
- Borrow the balance of your purchase. Leverage is the ability to borrow a percentage of the value of a piece of property. Real estate, in comparison to other investments, offers a very high degree of leverage. In some cases, one can obtain 95% financing. This allows individuals to purchase real estate with little, if any, of their own money. What other investments offer such a high degree of leverage?
Acquire Equity in 3 ways:
- Having your tenant pay down your mortgage. Your tenant pays you rent, which you then send to the bank to pay your mortgage. As you pay off the principal, you owe less than the home is worth. This is your equity.
- Property Appreciation. Appreciation is the increase in value of a property. If you were wise enough to buy below the market price, you start out with equity in the home, which only increases over time. What other appreciating asset can you purchase for less than its market price? We’ll find these by looking for distressed properties which are made up of Pre-Forecloses, Foreclosures (bank owned REO’s) and owners who want to sell fast.
- Improving The Property. You can give the property a face-lift or a full renovation or something in-between (depending on your planned use). Pay attention to the land as well – landscaping, fixing cracked sidewalks and driveways, and removing old trees can all be valuable. As you improve the neighborhood, you improve the value of your property. When you improve a property (through renovations), you force its value higher. You can purchase a piece of property in need of repairs and bring it back up to neighborhood standards or slightly higher; this will give you a property that is much higher in value.
Receive A Cash flow: Cash flow is the difference between your income and your expenses on a piece of property. It’s what you have after you’ve collected rent and paid out mortgage, taxes, insurance, upkeep, repairs and any management fees. You can have a positive or negative cash flow. Obviously, you’ll feel a lot better if the cash flow is positive. Most real estate produces some cash flow from collecting rent. While one may break even or just come out ahead with a new property, rents typically rise 3% – 5% a year. Within 15 years, today’s rent of $1,000 can increase to $1,500 to $1,800. Of course when the market declines, you may refinance and see a larger profit on your rent collections – since you will be paying the bank less every month and collecting the same (or more) in rent.
Receive Tax Write-Offs:What conversation about Real Estate would be complete without discussing the huge tax advantages of Real Estate? Many of the expenses are tax-deductible. One should hire a great CPA or Tax Advisory to make sure that write-offs and itemization are being used correctly. Following are just a few:
- If you live in your investment you can fix-up and sell every two years with up to $250,000 ($500,000 for couples) sheltered from tax as long as you actually lived there for two years. Serial renovators tend to do well here, trading up every two years.
- 1031 Tax Free Exchanges allow you to “exchange your property” with another investor and not pay taxes. Of course, this is a simplified version, as you don’t really exchange. As long as you claim it as a 1031 Tax Free exchange, you have a number of months to identify and use your profits to purchase another rental property and have the IRS consider it as an exchange.
- Depreciation is an accounting deduction that the IRS allows you to take for the overall wear and tear on your building. The idea behind this deduction is that, over time, your building will deteriorate and need upgrading, rebuilding, and so on. The IRS tables now say that for residential property, you can depreciate over 27-1/2 years, and for nonresidential property, 39 years. Only the portion of a property’s value that is attributable to the building — and not the land — can be depreciated.
- For example, suppose that you bought a residential rental property for $300,000 and the land is deemed to be worth $100,000. Thus the building is worth $200,000. If you can depreciate your $200,000 building over 27-1/2 years, that works out to a $7,272 annual depreciation deduction.
- If your rental property shows a loss for the year (when you figure your property’s income and expenses), you may be able to deduct this loss on your tax return. If your adjusted gross income is less than $100,000 and you actively participate in managing the property, you’re allowed to deduct your losses on operating rental real estate — up to $25,000 per year. Limited partnerships and properties in which you own less than 10 percent are excluded.
- To deduct a loss on your tax return, you must actively participate in the management of the property. This rule doesn’t necessarily mean that you perform the day-to-day management of the property. In fact, you can hire a property manager and still actively participate by doing such simple things as approving the terms of the lease contracts, tenants, and expenditures for maintenance and improvements on the building.
- If you make more than $100,000 per year, you start to lose these write-offs. At an income of $150,000 or more, you can’t deduct rental real estate losses from your other income. People in the real estate business (for example, agents and developers) who work more than 750 hours per year in the industry may not be subject to these rules.
- Deductions for money that you spend on the property, such as money for insurance, maintenance and repairs.
- Travel expenses to oversee the property if out of state.
Here are 6 tips from the National Association of Realtors for Better Investing…
- Think cash on cash. Determine your return based on the equity you have in the deal, not the total price of the property.
- Make your money on the buy. Don’t make the mistake of believing that the asking price represents the final price or value or expect short-term appreciation to bail you out. Do your analysis and negotiate.
- Get pre-approved for a loan. Otherwise you may miss a buying opportunity in this dynamic market.
- Protect your assets from lawsuits. Always hold each investment property in a limited liability company or other legal entity to protect the rest of your assets in case you are sued.
- Don’t buy more than you can manage. With more than 10 or so properties, you’ll probably need a professional manager or you may take too much time away from your career.
- Don’t overlook deductions. Even if a property is generating income, tax deductions for depreciation and expenses such as mileage related to managing your investment can reduce your taxable obligation.
And of course, with offices in Houston, San Antonio and Los Angeles – we specialize in California real estate investors who are buying, selling or leasing properties in the Houston area!
Please contact us for more information!