Minnesota's Real Estate Source

BUYING RENTAL PROPERTY: WHY IT MAKES SENSE! July 27, 2011

Why is buying rental property such a great investment?

There are four primary reasons that make real estate, namely, buying rental property, a great investment.

1.The first of these is cash flow. What is cash flow exactly? Well, to put it in simplest terms, cash flow is what money you have left over after the mortgages, the taxes, and the insurance have been paid. Again, the tenant pays you rent, and that money pays off these items. Whatever is left over goes into your pocket……that is cash flow.

2. Though many people buy rental property for “cash flow,” the real benefits that will build your net worth lie elsewhere. The second main “benefit” from buying rental property is the tax shelter that it creates for you. What does this mean exactly? Well, each time you buy a rental property, the IRS allows you to “depreciate” that property over 27.5 years. In other words, you can take this depreciation expense against your active income from your job. Let’s use a quick example:

Say you buy a $200,000 rental property. Again, the IRS lets you depreciate the building, not the land. Normally, 85% of the purchase price is used to determine the building, the physical house’s value. In this example, the IRS lets you depreciate $170,000 (the house) over 27.5 years. This is equal to $6,181 per year you can take a depreciation expense against your active income. In other words, say you make $80,000 in income from your job. Now, take $80,000 minus $6,181, which gives you $73,819. Now this is the income that you pay tax on, $73,819, not $80,000 (which you actually made.) Not too shabby huh!?!

You can see how by buying this “one little rental property,” you have reduced your taxable income significantly. As you guess, if you buy two houses, this number doubles, three, triples, etc.

I know some real estate investors that own enough rental property that they do not pay in federal or state income taxes because they have such a significant depreciation expense from all of their rentals.

3. The third main benefit from owning rental property is appreciation. As we know, not all debt is bad debt. In fact, any type of real estate debt you have is the best type of debt to have, for it is appreciating debt. Again, your home may not appreciate at 10%, or even 5% every year, but at the very least, it will go up over time. This is the area that most real estate investors build their long-term wealth. Buy the properties, and then hold them.

Time for another quick example: say you buy two rental homes totaling $400,000. Now let’s say those two homes appreciate 5% over 10 years. You now have homes that are worth $651,557.85. You have made $251,557 in equity by simply buying the houses and holding onto them. Not too bad, huh? Most say that sure beats what they make at their day job!.

Minnesota real estate, from 1940 to 2000, has appreciated 6.15% on average per year. (See this link below)
www.census.gov/hhes/www/housing/census/historic/values.html

We encourage you to go out and read the book Equity Happens. Go to www.EquityHappens.com to find out more about this awesome book. The basic premise of this book is yes, over time equity does happen. People have been talking about the “bubble bursting” with real estate since the 1950s. Yet in spite of this, real estate investors have continued to see slow and steady appreciation. Appreciation is real. Equity does happen

4. The last benefit from owning rental property is achieved through the paying down of the principal balance on your mortgages. Again, the rent you receive from your tenants will go towards paying those mortgages. Most of that money goes towards interest the bank charges you, however, some will go towards paying down the debt you owe. Over time you will build equity through paying down the loans as well.

However, you can see with the previous example at #3, if you merely pay “interest only,” on your loans, you will still gain considerable equity. In fact, the majority of your equity you build will be through appreciation, not through “paying down the loan.” For this reason, I am a firm believer in doing “interest only” types of loans. It allows you to cash flow more, to put more money in your pocket right now. What’s more, the home appreciates at the same rate no matter if you are paying $1,000 a month, interest only, or $1,800 a month, principal and interest. Cash flow is a wonderful thing that will allow you to continue buying properties. Cash flow allows you to leverage yourself, and control more appreciating assets, more real estate.

For more information visit www.investmentpropertyguys.com