Real estate purchased as a personal home is the typical way many care for the needs of their family; but other than a minimal tax write off for interest expense, and perhaps some accumulation of wealth through appreciation, the benefits of home ownership are not measured in the same financial terms as properties acquired through real estate investing. Homebuyers are looking for safe tree-lined neighborhoods, good school districts, ample amounts of bedrooms and bathrooms, and beautiful open floor plans.
Real estate investors never buy real estate investment properties based upon these things other than how they might influence rents and occupancy. Real estate investing is not about how beautiful the property is, but rather how much the investor's return on investment will be. The benefit of real estate investing boils down to four ways real estate investors plan for to make money on investment property.
1. Cash flow The primary purpose of most property investors, of course, is to rent out space in their asset with the intention to obtain rental income. Cash flow is generated after the property's operating expenses and debt service (i.e., mortgage payment) are deducted from this rental income. When more cash comes in than goes out the result is a "positive cash flow" that becomes periodically available to the investor on a regular basis.
2. Tax Shelter Real estate investment also provides an investor the benefit of being able to legally reduce his or her annual or ultimate Federal income taxes generally by allowing real estate investors to take deductions for the following:
- Acquisition costs - Most costs incurred at the time of purchase are deductible in the year of purchase.
- Property expenses - All expenses incurred in the operation of the property are deductible.
- Mortgage interest - The interest paid on the mortgage is deductible.
- Depreciation - The IRS also assumes that your buildings are wearing out and becoming less valuable over time and therefore allows you take a deduction for that presumed decline in what the tax code calls cost recovery (i.e., depreciation).
Of course there are nuances and exceptions in all tax matters that every investor should always discuss with a tax expert. But, you get the idea!
3. Loan Amortization Loan amortization is a periodic reduction of the loan over time. In other words, with a fully-amortized loan (i.e., not interest-only), each payment made reduces some amount of principal. The benefit surrounding real estate investing is that each time tenants pay the rent they are virtually paying down the debt and therefore helping the investor to buy the property.
4. Appreciation Appreciation is certainly not exclusive to rental income property. For any real estate sold for more than its original purchase price would benefit from appreciation whether it be a personal residence or office complex. With investment real estate, however, the owner does not necessarily have to leave appreciation to chance the way a typical homeowner would. The truth about real estate investing is that investors buy the income stream of a rental property. As a result, the more income stream a landlord can generate, perhaps by lowering vacancies or reducing wasteful expenditures, the more they can expect their property to be worth; and the sooner they can impose these changes, the sooner their rental property is likely to appreciate.
Rule of Thumb Real estate investing has proven to make money for investors. But it's not dictated by the same emotional feelings that may lead you to purchase a home for your family. It's all business. So approach it logically and always run all the numbers carefully before making any real estate investment decision. Here's to your success with your future investments!