So… you may be asking yourself, why should you buy or invest in real estate? Because this is an IDEAL investment! Let’s take a moment to discuss the reasons why people should own real estate investments. The easiest answer is a well-known acronym that discusses the main benefits for all real estate investments. Simply put, Real Estate Investing is an IDEAL investment. IDEAL stands for:
• Me – Earnings
• D – Depreciation
• E – Expenses
• A – Appreciation
• L – Leverage
Real estate is an IDEAL investment compared to others. I will explain each benefit in depth.
The “I” in IDEAL stands for Income. (aka positive cash flow) Does it even generate revenue? Your investment property must generate income from the rent it receives each month. Of course, there will be months where you may experience vacancies, but most of your investments will generate income. Be aware that often novice investors overestimate their assumptions and don’t take into account all the potential costs.
Investors should know when making a purchase that the property will PAY money each month (otherwise known as negative cash flow). AKDSEO merupakan agency digital marketing yang fokus melayani jasa Backlinks dan Link building website, termasuk di dalamnya Jasa Menaikkan DA ( Domain Authority) This scenario, while not ideal, may be fine, only in certain cases which we will discuss later. This boils down to risk tolerance and the ability of the owner to fund and pay for negative producing assets.
In the years of the real estate boom, prices were very high and rents did not increase in proportion to many residential real estate investment properties. Reed Manning, Spa & Salon Many naive investors buy property on the assumption that price appreciation will more than offset the fact that a high-balance mortgage will have a significant negative impact on funds each month. Be aware of this and do your best to forecast positive cash flow scenarios, so that you can truly embody the INCOME part of the IDEAL equation.
Often times, it may require a higher down payment (hence a lower mortgaged amount) so that your cash flow can be received each month. Ideally, you end up paying off the mortgage so there’s no question that cash flow will come in every month, and that’s basically it. It should be an important component to one’s retirement plan. Do this a few times and you won’t have to worry about money later on, which is both the main goal and the reward for taking the risk in buying an investment property in the first place.
The letter “D” in IDEAL stands for Depreciation. With real estate investing, you can use depreciation to your own tax advantage. What is depreciation? It is a non-cost accounting method to account for the overall financial burden incurred through real estate investments.
Look at this another way, when you buy a new car, once you get out of the parking lot, its value depreciates. When it comes to your real estate investment properties, the IRS allows you to deduct this amount each year against your taxes. Please note: I am not a tax professional, so this is not intended to be a lesson in tax policy or to be construed as tax advice.
Thus, the depreciation of a real estate investment property is determined by the overall value of the property structure and the length of time (recovery period by property type – both residential and commercial). If you ever get a property tax bill, they usually divide the value of your property into two categories: one for land value, and the other for structure value.
These two values added up equal your total “base” for property taxation. In case of depreciation, you can deduct your tax on the original base value of the structure only; The IRS does not allow you to depreciate the value of land (because land is usually only VALUE). Just like your new car is driving, property structures decrease in value with age. And you can use this to your tax advantage.
The best example of the benefit regarding this concept is through depreciation, you can actually turn a property that creates a positive cash flow into one that shows a loss (on paper) when dealing with taxes and the IRS. And by doing so, that (paper) loss is deductible against your income for tax purposes. Therefore, it’s a great benefit for people that are specifically looking for a “tax-shelter” of sorts for their real estate investments.
For example, and without getting too technical, assume that you are able to depreciate $15,000 a year from a $500,000 residential investment property that you own. Let’s say that you are cash-flowing $1,000 a month (meaning that after all expenses, you are net-positive $1000 each month), so you have $12,000 total annual income for the year from this property’s rental income. Although you took in $12,000, you can show through your accountancy with the depreciation of the investment real estate that you actually lost $3,000 on paper, which is used against any income taxes that you may owe.
From the standpoint of the IRS, this property realized a loss of $3,000 after the “expense” of the $15,000 depreciation amount was taken into account. Not only are there no taxes due on that rental income, you can utilize the paper loss of $3,000 against your other regular taxable income from your day-job. Investment property at higher price points will have proportionally higher tax-shelter qualities. Investors use this to their benefit in being able to deduct as much against their taxable amount owed each year through the benefit of depreciation with their underlying real estate investment.
Although this is a vastly important benefit to owning investment real estate, the subject is not well understood. Because depreciation is a somewhat complicated tax subject, the above explanation was meant to be cursory in nature. When it comes to issues involving taxes and depreciation, make sure you have a tax professional that can advise you appropriately so you know where you stand.
The “E” in IDEAL is for Expenses – Generally, all expenses incurred relating to the property are deductible when it comes to your investment property. The cost for utilities, the cost for insurance, the mortgage, and the interest and property taxes you pay. If you use a property manager or if you’re repairing or improving the property itself, all of this is deductible. Real estate investment comes with a lot of expenses, duties, and responsibilities to ensure the investment property itself performs to its highest capability.
Because of this, contemporary tax law generally allows that all of these related expenses are deductible to the benefit of the investment real estate landowner. If you were to ever take a loss, or purposefully took a loss on a business investment or investment property, that loss (expense) can carry over for multiple years against your income taxes. For some people, this is an aggressive and technical strategy. Yet it’s another potential benefit of real estate investment.
The “A” in IDEAL is for Appreciation – Appreciation means the growth of value of the underlying investment. It’s one of the main reasons that we invest in the first place, and it’s a powerful way to grow your net worth. Many homes in the city of San Francisco are several million dollars in today’s market, but back in the 1960s, the same property was worth about the cost of the car you are currently driving (probably even less!).
Throughout the years, the area became more popular and the demand that ensued caused the real estate prices in the city to grow exponentially compared to where they were a few decades ago. People that were lucky enough to recognize this, or who were just in the right place at the right time and continued to live in their home have realized an investment return in the 1000’s of percent.
Now that’s what appreciation is all about. What other investment can make you this kind of return without drastically increased risk? The best part about investment real estate is that someone is paying you to live in your property, paying off your mortgage, and creating an income (positive cash flow) to you each month along the way throughout your course of ownership.
The letter “L” in IDEAL stands for Leverage – Many people refer to this as “OPM” (other people’s money). This is when you use a small amount of your money to control a much more expensive asset. You essentially take your down payment and gain control of an asset that you wouldn’t normally be able to buy without the loan itself. Leverage is much more acceptable in the real estate world and inherently less risky than leverage in the stock world (where this is done through options or purchases “with Margin”). Leverage is common in real estate.
Otherwise, people will only buy property when they have 100% of the cash to do so. More than a third of all purchase transactions are cash transactions as our recovery continues. However, about 2/3 of all purchases are made with some level of financing, so most buyers in the market enjoy the power that leverage can offer when it comes to real estate investing.
For example, if a real estate investor is going to buy a $100,000 house with a 10% down payment, they take the remaining 90% through the use of the associated mortgage. Let’s say the local market increases by 20% over the next year, and therefore real property is now worth $120,000. In terms of leverage, from the point of view of this property, the value is increased by 20%.
But compared to the investor’s actual down payment (“skin in the game”) of $10,000—this 20% increase in property value actually means the investor doubles the return on investment actually made—also known as the “cash” return. In this case, it’s 200%—because the $10,000 is now in charge and entitled to a $20,000 increase in overall value and potential overall profit.
While leverage is considered a benefit, like anything else, there is always too much of a good thing. In 2007, when the real estate market took a turn for the worst, many investors were overcapitalized and fared the worst. They cannot weather the economic storm that is undergoing correction.
Being careful with every investment you make will help ensure that you can buy, hold, pay off debt, and grow your wealth from investment decisions made as opposed to the mercy and whims of overall market fluctuations. There will definitely be booms and busts in the future because the past will determine when we keep moving forward. More planning and preparation while building net worth will help prevent losses and crashes from the side effects of any market we face.
Many people think that real estate investing is all about cash flow and appreciation, but it’s more than that. As noted above, you can realize several benefits through each real estate investment property you purchase. The challenge is to maximize profit through each investment.
Furthermore, the acronym IDEAL is not just a reminder of the benefits of real estate investing; It also serves as a guide for any investment property that you will consider buying in the future. Each property you buy must match all the letters that represent the acronym IDEAL.
The underlying property must have good reason not to comply with all guidelines. And in almost every case, if there’s an investment you’re considering that doesn’t meet all of the guidelines, according to most accounts, you should probably PASS!
Take, for example, my own story, about a property I bought early in my real estate career. To this day, this is the biggest investment mistake I’ve ever made, and precisely because I didn’t follow the IDEAL guide that you’re reading and studying right now. I’m still naive and my experience isn’t fully developed. The property I purchased was vacant land in a gated community development.
The property already has an HOA (monthly maintenance fee) because of the convenience facilities built for it, and in anticipation of the house to be built. There were high expectations for a potential future appreciation – but then the market took a turn for the worse as we headed into the expected major recession from 2007-2012. Can you see which part of the IDEAL guidelines I missed completely?
Let’s start with “I”. Vacant land does not generate income! Sometimes this is acceptable, if the deal is something that cannot be missed. But most of these deals are nothing special. To be honest, I’ve considered selling the trees currently on the vacant lot to a local lumber mill for real income, or advertising a camping spot on the local Craig’s list; but sadly the wood is not worth enough and there are better places to camp! My hopes and desires for price appreciation preclude the rational and logical questions that need to be asked. So when it comes to the income aspect of the IDEAL guidelines for real estate investing, I don’t pay attention to it.
And I paid the price for my arrogance. Also, this investment fails to realize the depreciation benefit because you can’t depreciate the land! So, so far we’re zero for two, with IDEAL guidelines for real estate investing. All I can do is hope the land is appreciated so that it can one day be sold. Call it an expensive study lesson. You will also have these “learning lessons”; just try to have as few of them as possible and you will be better off.
When it comes to maximizing your real estate investments, ALWAYS keep the IDEAL guidelines in mind to ensure you make good decisions and solid investments