Month: April 2017

Benefit of Real estate – Total benefits

It’s time to pull all this together and see the overall numbers on real estate investing.  The benefits include monthly cashflow, appreciation of the property, mortgage being paid down every month and the tax benefit called depreciation.  So let’s look at the example I’ve used in other posts on this blog of one of my rental properties.

Cashflow

Income

Rent – $1,550

 

Expenses

Mortgage -$667

Taxes – $450

Insurance -$60

Maintenance $100

Total expenses = $1,277

 

Profit = $1,550 – $1,277 = $273/month or $3,276/year

 

As you can see here the monthly cashflow on my property is $273.  So if we want to know what that will be over 30 years we can multiply that by 360 month.  That numbers is $98,280.  But we didn’t figure in that over time rents rise.  If we take into account an average annual rent increase of 1% that figure climbs to $188,280 or $6,276/year profit.  Now over those 30 years the mortgage payment stays the same but the taxes and insurance increases.  If those increase at 1% and rents increase at about 2% per year, we have our 1% gain.  So just on cashflow alone we have returned a 18% profit off our initial investment of $35,000.  

Now let’s add in the appreciation of the property combined with the paying down of the mortgage, which the tenant does for us.  This property I discussed in another blog post here.  The initial value is $175,000.  Assuming an annual average increase in value of 3%, after 30 years we own an asset that is worth $430,000.  This comes out to an annual profit of $14,333 or a 41% return on the initial downpayment we made of $35,000.  

So on the initial investment of $35,000 we made:

$188,280 in cashflow

$430,000 in asset appreciation while the mortgage was paid down to zero

Totalling $618,280 over 30 years.  That is $20,609 made each year which gives us an annual return on investment of 58.8%.  Wow!  But wait!  We have to factor in the benefit of depreciation which means that we have paid little to no taxes on this gain over those 30 years.  Let’s assume a 20% tax rate on this cashflow.  That $188,280 should have resulted in taxes of approximately $37,600 but did not due to us being able to depreciate the property.  Adding this into the equation gives us a total of $655,936 (or $21,864/year) which equates to a total ROI (return on investment) of 62.5%.  

As you can see here, real estate over the long haul has the ability to greatly build wealth.  Most of the gains discussed here came from appreciation and mortgage reduction over time.  You really have to take the long term approach as the monthly cashflow doesn’t look all that impressive.  If you do however practice that patience and keep at it over the years, you can see the incredible value you wind up with.  I hope I’ve made a solid case for real estate investing as a fantastic long term investment that you might consider.  

Benefit of Real estate – Appreciation and Mortgage paydown

As you hold a piece of rental property, assuming you do it right, you gain money each month from cash flow.  This is a nice recurring benefit that puts a little money in your pocket each month but it is not the greatest or most profitable part of real estate investing.  Those who think longer term are the ones who find the greatest gains in real estate and earn riches.  

We must keep in mind that over extended amounts of time real estate increases in value.  Notice I said extended amounts of time!  You can’t rely on your property to increase in the short term.  In fact, in recent years if that was your goal you were greatly disappointed!  I think a lot of people miss the value here because we’d like to see the money flowing in today.  We don’t want to wait 30 years till the mortgage is paid off to get rich.  But if you do wait, you’ll be glad you did.  Those 30 years of managing your property will have paid off big time.  Let me show you how.

Appreciation rates vary per area that you live in but a conservative appreciation rate would be about 3% over time.  So let’s look at one of my properties.  It is the same as the one I give on monthly income/expense comparison.

5 years ago my partner and I bought a single family home for $175,000.  We put 20% down so the mortgage was $140,000.  Here is the breakdown of what our equity would look like every 5 years of holding the property considering appreciation of 3% and the mortgage being paid down over time (by our tenant not us).

See the chart below for equity after: 5, 10, 15, 20, 25 and 30 years

 

Property value Mortgage balance Equity
203,300 127,600, 75,600
236,100 112,100 124,000
274,300 92,700 181,600
318,600 68,400 250,200
370,100 38,000 332,100
430,000 0 430,000

 

So that is a nice little gain over the course of 30 years.  You now have an asset that is valued at $430,000 and you own it free and clear.  If we take $430,000 and divide by 30 years we get the average gain per year which is $14,333.  Now remember that our initial investment was $35,000.  This equates to a whopping 40% annual return on our investment.  This doesn’t even take into consideration the money that we received from our monthly cashflow over those 30 years.  

I hope you are starting to get excited about real estate as an investment.  It takes time but over the long haul I don’t believe there is a better long term investment.

Benefits of Real estate – Cashflow

Real estate has many benefits and I think a lot of people don’t understand all the reasons that it is a great investment so let me begin discussing them.  One reason is that real estate can be a source of passive income.  Passive income is money you receive without having to work for it, or having to work very little for it.  This is so important because we all have limited amounts of time and if all your income is spent working for it, it is limited just like your time.  

 

The great thing about real estate is that if you set it up correctly, you will get paid each month for having to do very little work.  Over time this really adds up and is a great source of income.  My properties average about $300/month of pre-tax profit after all expenses are accounted for.  Most of the time I just check that my tenants deposit was paid the first of the month and, because I spent the time finding a good tenant, it always is.  

 

Below is a breakdown of the income and expenses from one of my properties.  This has been the situation over the last 5 years.

 

Income

Rent – $1,550

 

Expenses

Mortgage -$667

Taxes – $450

Insurance -$60

Maintenance $100

Total expenses = $1,277

 

Profit = $1,550 – $1,277 = $273/month or $3,276/year

 

And the great thing is that over extended periods of time rents go up so I’m only going to be increasing my monthly cashflow over the years.  There isn’t a lot you can do to decrease expenses from this list as you can’t control mortgage rates, property taxes or insurance rates.  But one thing you can keep a tight reign over is maintenance costs.  If you don’t fix the property the right way the first time and continue to use quality workers to fix it up (or do it yourself if you’re handy) maintenance can eat you alive and turn your profitable property into a losing proposition.  I recommend building a list of high quality, trusted professionals to turn to when your property needs work.  One we use close to us is Houston Plumbers.  They’ve served us well for years and in my opinion are the best plumber Houston, TX has to offer.  

You may look at this and be underwhelmed by only $3,276/year profit and I can understand that, especially when you look at the risk of carrying the property and that values ebb and flow over the years.  Fortunately cash flow is only one of the ways you make money on real estate.  I’ll cover the others below as I build my case for real estate being a great way to earn great riches.

Benefit of Real estate – Depreciation

Real estate, in my opinion, is a fantastic long term wealth-building investment.  The monthly cashflow is solid when you manage it correctly, or have someone else do it correctly.  The appreciation over time combined with fact that the mortgage is being paid down by the tenants provides for a sneaky good annualized Return on investment over the life of the loan.  All these add up to a great investment but the one aspect of real estate investment that people often overlook is depreciation.  

So what is depreciation?  Depreciation is the loss in value of your property over time due to wear and tear, aging and deterioration.  Although a piece of property typically increases in value, in the governments eyes it is losing value in that it is deteriorating.  Thus you as the owner are given the benefit of depreciation meaning you can deduct this wear and tear your property is experiencing from the profits you get.  

The outcome is often that your taxes are completely offset by the depreciation.  Sometimes your real estate can even come out as a loss on your taxes even if you are putting money in your pocket over the year.  Isn’t real estate fantastic!  It’s been said that your largest expense is taxes and that is usually true.  What depreciation does is largely or completely eliminate the taxes you are paying on your investment.  This is no small benefit and adds to your bottom line over time. If you are looking to do some hardwood floor refinishing in Atlanta, GA. then check out today’s sponsor.