Q: Hello, I am a month away from turning 50 and would like to make smarter investment decisions for the second half of my life. When it comes to real estate investing I’m familiar with cash flow but am fuzzy on the other kinds of return I could earn. Please fill in the blanks. Thanks.
A: Hi Joel, so you wanna be a self-employed real estate mogul, eh? Congratulations on two fronts. First, on your upcoming celebration, and second on deciding to make a sharp left turn in regards to your finances. Choosing to transform into a tycoon at the ripe old age of 50 (or any age) could not be a better one.
Get started with one small property that you can easily afford. Use that as a first-step and a learning experience. Over time, parlay that building into another, and another, and then maybe even another.
Real estate offers several different types of returns, all of which budding entrepreneurs like you need to know about.
The money in your pocket
The first return is cash flow. Simply put, cash flow is the money that is left over after paying all your operating expenses and loan payments.
To calculate cash flow you need to know three things. They are:
- The annual gross income of the property
- The annual expenses on the property
- The total debt payment on your loans
Subtract your expenses and loan payments from your gross income and you will be left with your cash flow. In time, figure out ways to increase your income, reduce your expenses, and pay less on your loans and your cash flow will increase. More cash flow = a happier life.
Paying down your loans
You are also going to make money from loan reduction. By paying down on your loans each month you will thereby be decreasing your principle balance owed.
Principle reduction happens slow at first but increases exponentially as your years of ownership roll by. Odds are, when it comes time to sell or trade up you will be thrilled at the amount of principle reduction you have achieved.
Appreciation for appreciation
The third way you are going to earn is through value appreciation due to both inflation and demand.
Inflationary appreciation sounds just like what it is – the increase in your property’s value due to inflation. It is the same occurrence you see time and again in regards to supermarket prices. Even though the number of items in your cart stays the same, prices continue to go up year after year after year.
The same principle will hold true for the value of your investment property. As the years go by it will take more dollars to buy the same property.
To be sure, value appreciation will only happen over the long haul, but if you are patient this return on your investment will always prove to be significant.
The tax man cometh, but he doesn’t have to taketh
The great news is that our tax code has a lot of wonderful advantages that real estate investors can take advantage of.
First, as an owner of income producing property you will now be able to deduct all the costs of running your new business from the income that that property produces. You will also be able to deduct any interest on the money you borrowed to buy that property.
Finally, you will be able to take a deduction each year for the depreciation of your property. Note that the depreciation deduction is not a real, current expense that will take cash to pay, but rather it is just a paper loss. This paper loss helps shelter some of the net income of the investment from taxes and this savings is a return you can count on.
To add icing to the cake, if you have enough depreciation left over you may even be able to save some tax on your salary from work. Make sure to ask your accountant about this so as to take advantage of all the benefits the law provides.
Joel, the most important thing you are doing is choosing to start investing for your future. Bravo!
If you read the papers and listen to the financial reports certainly you realize the retirement situation for most Americans is in dire straights. Now, more than ever, it is crucial for the Average Joe(l) to take control of their own financial future.
Get started with one small property that you can easily afford. Use that as a first-step and a learning experience. Over time, parlay that building into another, and another, and then maybe even another. If you do you will find that real estate will provide you with a multitude of great returns.
Have a real estate question for the experts from Real Estate 2.0? Email the guys at [email protected].
Combined, Marty Stone and Spencer Strauss have been helping people like you make millions in real estate for over 40 years at their firm, Buckingham Investments in Southern California. But theirs is not some get rich quick scheme. Instead, their proven real estate investment strategies help small investors take advantage of naturally occurring forces in the real estate market in order to become big investors.