This article is an excerpt from our no cost Ultimate Guide To Passive Investing. You can download the full guide here.
Real Estate has five fundamental benefits that make real estate stand out from the rest. Each benefit on their own is powerful, yet together I found they make real estate the smartest and most reliable investment we can make.
Here are the Five Core Benefits of Holding Real Estate Investments
- Produces cashflow
- Builds Equity
- Potential for Appreciation
- Uses Leverage to increase returns
- Incredible Tax Benefits and Advantages
Why Real Estate is the Smartest Investment
Every dollar that you invest in real estate goes to work for you and in more ways than one.
Cashflow is one of the key factors that separates real estate from the rest.
Unlike other types of investments real estate generates passive cashflow, which means you literally make money while you sleep.
How does cashflow work?
When you invest in a real estate asset, you’re buying that asset to rent it out to tenants who then pay you for the opportunity to live there or use your property. Once you pay all your expenses, the rest of that rent check is yours to keep, aka, your cashflow.
Cash flow = passive income. Passive income = money you make in your sleep
Let’s break down an example using a single family deal for simplicity.
Let’s say you put down $25,000 to buy a single family rental for $100,000.
Your mortgage is $500 per month.
You rent it out for $1,000 per month.
On the first of the month, your tenant sends you a rent check for $1,000. You use $500 to pay the mortgage, $350 for expenses and reserves. The remaining $150 is your passive cashflow. True “Mailbox Money.”
Now let’s imagine those numbers, but much larger for a commercial property:
Purchase Price: $10,000,000
Monthly Mortgage: $50,000
Monthly Total Rent: $100,000
Monthly Expenses & reserves: $35,000
Passive Cash Flow: $15,000
Keeping our numbers manageable, we’ll bump them back to our original example.
In our example you bought a $100,000 property, but didn’t pay $100,000 in cash.
Rather, you paid $25,000 towards the down payment, and the bank partnered with you to bring the other $75,000 to the table. However the cashflow you earn is based on the full value of the asset. You’re earning cashflow on the $100,000, not the $25,000 you put in.
Put another way, the bank put up most of the money, however you are able to reap the full rewards. The bank is happy with their set rate of return, but your ROI is dramatically higher than buying with cash because you used leverage the smart way. You leveraged with control.
Let’s see the difference in a graph!
|Cost of Debt||$1,200,000||$0|
|Sale of Asset||$11,000,000||$11,000,000|
|Return on Investment||54.4%||25.6%|
Each month as those rental checks come in, a portion of it goes to cover your mortgage, which is increasing your equity. It’s a little bit each month, but that means your tenant is actually paying for your property. You get to double dip on upsides of investing in real estate.
In other words, the rental property generates income to pay for itself.
Your tenants are essential building that equity for you.
After a period of time, investors will refinance the property, pulling out the equity and paying off investors. Or sometimes they’ll take a line of equity on the property to cover new improvements to improve the properties value to increase property income.
Historically the value of real estate goes up over time. Sometimes faster in some markets than others. This means that the value of your property “could” go up during the time you hold it. This is referred to as appreciation, and it’s one of the benefits of real estate investing.
There are few assets that go up over time. When you buy a car, it loses value when you drive it off the lot. But oftentimes after buying real estate, you’ll see values increase overtime.
Appreciation is a nice-to-have, yet it’s not a guarantee, which is why most people recommend buying for cashflow, first and foremost. This leaves appreciation as a nice cherry on top.
Taxes Are a Big Deal
Tax benefits are a HUGE way that your money goes to work for you in real estate and one of the most important reasons that real estate is an incredibly smart investment.
The tax code is written to reward certain types of activities
Real estate is one of them – the government has realized that it needs investors’ help to provide that housing and created a tax break for investors.
When you invest in real estate, you get the benefits of depreciation, as well as a whole host of write-offs for a number of other related expenses.
The Power of Paper Losses
You hear about this in the news. Oftentimes because you’re receiving all the tax benefits, you’ll show losses on paper while actually making money through cashflow.
The paper losses can play a big part in helping to offset some of your other income (i.e., income from your job). This likely results in a lower overall tax bill, even though your income will likely be higher.
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