Real estate investments are the key to some of the most successful people in the world. How is real estate investing able to create wealth?
These are the top driving forces for real estate success.
Equity refers to ownership. Your personal equity in real estate investing is the difference between the property’s market value and the amount you owe the bank on the mortgage. If your property is worth $150,000 but you owe $120,000 to the bank, then you have $30,000 equity.
Forced equity refers to the wealth you create when you purchase a property for a lower price and make it more valuable. A “distressed property” is typically sold for 25%-30% more than a similar property that isn’t in distress. It takes 10-15% to repair it (carpet, paint and some replacement appliances), and bring it back to its market value.
Let’s suppose you paid 25% less than the market value. Then, you spent 10% to fix it. This will increase your equity (ownership) 15%
You can also force equity by adding features that increase the property’s value. Imagine that you purchase a house with two bedrooms in a neighborhood with three bedrooms. Your property would be comparable to the market value of other properties if you added the third bedroom. If you buy the house at an appropriate discount because it only has two bedrooms, and the cost of adding another bedroom is less that the difference in your price and the market value, then you have earned equity.
In most cases, depreciation is a negative thing. It is the loss of value.
However, real estate investing does not mean a drop in property value. Real estate investors have a tax benefit that the IRS offers. You can deduct a portion of the investment property’s value each year for the IRS-determined lifetime.
The IRS states that residential properties have a useful life expectancy of 27.5 years. For example, let’s say your property is worth $150,000. You can subtract $5,454 from rental income. Let’s say your annual net rental income is $15,000. Say your net annual rental income is $15,000. Your taxable rental income falls to $9,546.
This depreciation tax cut is so powerful because most real estate doesn’t lose value every year. Property values tend to increase over time. This means that you can get a tax credit for an asset that is likely to increase in value.
Depreciation, which is a tax credit, is added to property upkeep costs and other costs you can subtract from your rental income. A cash-positive rental can become a loss on paper due to depreciation. This loss can lower your overall tax bill and reduce your other taxable income.
One of the most popular wealth-creating real estate investment strategies is leverage. This is borrowing capital to buy or increase the return on investment. Leverage allows real estate investors to make more money with an income-producing asset than their cash outlay. Let’s take, for example, 20% down on a $100,000 property and finance 80%. Leverage allows you to control and benefit from the income generated by a $100,000 property even though you only invested $20,000.
Real estate agents love to refer to leverage as the ability to “make money with other people’s money”. The bank funds are used to buy the property, and the money of the tenant to repay the bank. Your profit is the difference between what the tenant pays and what you pay the bank. You could have $500,000 worth real estate assets instead of buying one house for $100,000 with cash.
We all take inflation as a given. We are forced to pay more for everyday goods because the price of them is increasing. We don’t pay much attention to it. It is a cost that does not discriminate but affects everyone. So why complain?
Many large companies offer an annual “cost of living raise” to help employees understand how inflation affects their ability to provide for their families. Inflation is only one aspect of the economy. The average annual inflation rate in the United States is 3%. However, there have been years of high inflation (12.5% for 1980), and low inflation (0.1% for 2008).
Inflation can be a reliable and consistent source of wealth for real estate investors. Because inflation is a constant driver of home price appreciation, Fixed-rate mortgages have a monthly payment that remains the same for thirty years. If at all, taxes and insurance rise very slowly. This means that although the investment property’s value is rising each year due to inflation, its cost is still relatively low. Inflation is the difference. Equity means you have a more valuable asset each year.
Inflation leads to a gradual rise in the value of your investment properties, but rapid market appreciation is a major factor that creates wealth. From 1968 to 2009, the average price of existing houses increased by 5.4% per year.
Real estate is all about location. You can expect your investment to increase year after year if you have done your research and bought a property that has a high value. This is how many people have made large sums of money in real property.
Real estate investing follows the same principles as stock market investing. Buy low, sell high. Some areas of the country like California have seen their home values rise much faster than inflation.
Annual Rent Increases
Housing is the cost to life. Inflation leads to an increase of food and other consumer goods. Housing costs keep up with inflation. Due to inflation, it is common to see rents rise by 2.5 to 5% every year. It is common for landlords to increase rents every time a lease term is renewed.
If your mortgage interest rate remains fixed, however, your rental property costs won’t rise with inflation. Your rental income will increase while your costs will remain the same as a landlord. Your investment property will bring you more profits year after year.
Be aware of the risks
These are the main strategies real estate investors use in order to make money. There is always risk with any investment. It is important to be smart about your investments, to manage well and not become too dependent.
Real estate investing requires more time and effort than stock trading. You also get higher returns if you take on more risk. Real estate is a long-term investment, unlike other options. Because it is a fixed asset, which can’t be liquidated quickly, and because transaction costs are high, this makes real estate a long-term investment. It is important to understand the risks and take steps to mitigate them.