Property purchased as a personal residence is the typical way many care for the needs of their family; but other than a minimal tax write off for interest expense, and perhaps some accumulation of wealth through appreciation, the benefits of home ownership are not measured in the same financial terms as properties acquired through real estate investing.
Home buyers are looking for safe tree-lined neighborhoods, good school districts, an ample amount of bedrooms and bathrooms, and beautiful open floor plans.
Real estate investors never buy investment property based upon these things other than how they might influence rents and occupancy.
Real estate investing is not about how beautiful the property, but rather how much the investor’s return on investment. Or as one investor once told me, “Only women are beautiful. What are the numbers?”
Fair enough. So let’s talk numbers.
The benefit of real estate investing boils down to four ways investors plan for to make money on investment property.
1. Cash flow
The primary purpose of most property investors, of course, is rent out space in their asset with the intention to collect rental income.
Cash flow is generated after the property’s operating expenses and debt service (i.e., mortgage payment) are deducted from this rental income. When more cash comes in than goes out the result is a “positive cash flow” that becomes periodically available to the investor on a regular basis.
2. Tax Shelter
Real estate investment also provides investors the benefit of being able to legally reduce his or her annual or ultimate Federal income taxes generally by allowing the owner to take deductions for the following:
- Acquisition costs – Most costs incurred at the time of purchase are deductible in the year of purchase.
- Property expenses – All expenses incurred in the operation of the property are deductible.
- Mortgage interest – The interest paid on the mortgage is deductible.
- Depreciation – The IRS also assumes that your buildings are wearing out and becoming less valuable over time and therefore allows you take a deduction for that presumed decline in what the tax code calls cost recovery (i.e., depreciation).
Of course there are nuances and exceptions in all tax matters that every investor should always discuss with a tax expert. But you get the idea.
3. Loan Amortization
Loan amortization is a periodic reduction of the loan over time. In other words, with a fully-amortized loan (i.e., not interest-only) each payment made reduces some amount of principal. The benefit surrounding real estate investing is that each time tenants pay the rent they are virtually paying down the debt and therefore helping the investor to buy the property.
Appreciation is certainly not exclusive to rental income property. For any property sold for more than its original purchase price would benefit from appreciation whether it be a personal residence or office complex.
With investment property, however, the owner doesn’t necessarily have to leave appreciation to chance the way a typical home owner would. The truth about real estate investing is that investors buy the income stream of a rental property.
As a result, the more income stream a landlord can generate, perhaps by lowering vacancies or reducing wasteful expenditures, the more they can expect their property to be worth; and the sooner they can impose these changes, the sooner their rental property is likely to appreciate.
Rule of Thumb
Real estate investing has proven to make money for investors. But it’s not dictated by the same emotional feelings that may lead you to purchase a home for your family. It’s all business. So approach it logically and always run all the numbers carefully before making any real estate investment decision.
Here’s to your success.