Investing in real estate has long been one of the most popular and powerful ways for investors – both seasoned and just starting out – to establish and grow a significant amount of wealth.
That’s because unlike most other types of investments, real estate provides a variety of different ways in which you can generate revenue and build value. Through comprehensive due diligence and smart investing, real estate can help you grow your nest egg in each of the following ways:
For many people – especially new investors – dreams of building wealth through real estate often center on locating a good deal, spending a little bit of time and money to fix it up, and then turning around and selling the property for a hefty profit.
There are deals like this around, but they are not abundant. It takes a great deal of time and effort to locate a property that has hidden value.
Short term appreciation – less typical
This type of fix-and-flip investing focuses on building equity through forced appreciation. This occurs by making improvements that significantly increase the market value of the property.
For example, an investor might buy a single-family home for $160,000, put another $25,000 into repairs, and then sell the property a couple of months later for $229,000 – netting them a considerable $49,000 profit.
Long term appreciation – more typical
Long-term investors also benefit from appreciation, albeit more slowly. Real estate historically increases in worth by around 3% each year on average. Sure, the last few years have seen some property values increase by far more than that on a year-over-year basis. But we’ve also seen that properties can sometimes decrease by double digits when the economy takes a dive.
However, on a long term basis, most investments in non-declining neighborhoods can expect to see annual equity growth through traditional appreciation. At 3% growth, a $200,000 property would be worth nearly $315,000 in 15 years, and more than $485,000 after 30 years.
Although a 3% annual appreciation may not meet the returns of other alternative investment options, long-term investors are able to stack that equity growth with the other techniques on our list to generate huge returns and wealth over time.
- Positive Cash Flow
Every investor has a financial goal and a plan for how to achieve it. But other than a few specific situations, most long-term real estate investors prefer to pursue deals that offer a positive cash flow.
Cash flow is the amount of money left over from an investment’s rental income after all expenses and obligations have been paid. It’s basically the profit you receive from your investment on a monthly basis.
The problem with cash flow, however, is that it isn’t always consistent. Unexpected expenses, such as repairs and vacancy, can have a big impact on cash flow. That means it is crucial to have funds in reserve for months when the money coming in doesn’t quite match up with the bills going out.
- Borrow using other people’s money
Real estate differs from other types of investments in a variety of ways, but one of the most significant is the extent to which investors are able to utilize leverage. This concept is often referred to in the industry as using Other People’s Money (OPM), though most of us know it as a mortgage.
The mortgage typically allows owners to maximize their returns while minimizing the amount of their own funds that are put into each deal.
It’s an idea everyone understands. Most home buyers take out a mortgage in order to buy a personal residence. In that same manner, real estate investors typically borrow money from lenders to purchase their investment properties.
When you’re a homeowner, the monthly mortgage that you pay slowly reduces the total amount you owe and builds equity in your home. Some day, if you decide to move, you hope to sell at a profit.
Build equity using other people’s money
In an investment property, the same concept applies, but with one vital difference. The owner’s payment is supplied by the rent received from tenants. So with investment property, not only have your borrowed other people’s money to buy the property, but you’re also using other people’s money to pay down the mortgage and build equity.
- Tax Deductions & Incentives
There are numerous tax benefits that can accrue to real estate investors. Among the most intriguing of these is something called a 1031 exchange. This is based on Internal Revenue Code section 1031. Using this process, an investor may be able to sell an existing property and reinvest the proceeds into another property within 180 days, without paying immediate capital gains taxes on the sale.
There are many specific details and protocols which must to be followed – such as identifying potential replacement properties within 45 days and limiting the search to what is termed “like-kind” investments. However, while a 1031 Exchange may lead to significant tax savings, the process is not for the inexperienced investor and it may create very unpleasant tax consequences if not conducted in the legally prescribed manner.
NOTE: While this may sound very exciting, every investor, including those who are highly experienced, should consult an accountant and a real estate attorney, preferably one who specializes in 1031 exchanges, before even thinking about this type of transaction.
Many other investment vehicles generate profits through appreciation in value or regular cash flow disbursements. Real estate gives investors the ability to maximize wealth in both of those regards, as well as through mortgage repayment and tax deductions and incentives.
Real estate investment is a team sport
If real estate appeals to you an an investment vehicle, talk to your realtor insurance agent, mortgage banker, title company, your accountant and your attorney so you know what you can and cannot afford to do. Once you know the answers to that question, ask your real estate agent to locate income generating properties that fit within your investment parameters.
Take due diligence very seriously.
While real estate investment can be a very enjoyable way to make money, it can also become a big problem if you have not planned for contingencies. So double check your due diligence before you get excited. If the numbers still make sense after you’ve taken a second look, ask your agent to make a reasonable offer.
Look hard enough and you’ll find a good property.
When you first start looking, it may seem hard to find property that makes financial sense. But once you spend some time looking and learning, you’ll find that there are large numbers of profitable investment opportunities available.