Buying Rental
Property: Why it Makes Sense!
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!.
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.
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