Jan
03

Real Estate Investing Basics: Part One

Why is real estate a great investment vehicle?

Are you interested in investing in real estate? Do you want to learn more about how it is done and different tools to buy and hold the right properties? You have come to the right place! This three part series simplifies why real estate can be a great investment vehicle, what tools you can use to start buying and managing properties, and shows an actual investment example with calculations.

Real estate can be a great investment if you educate yourself and find the right property. The old real estate investment saying is “You make your money when you buy,” so make sure you do your homework and get the best deal out there! There are many good reasons to purchase and hold real estate. I have summarized four main points below:

  1. Real estate can be an asset that produces a positive income with little work required to maintain and operate it, especially if you hire a great rental management company like Feel Good Property Management. This monthly income is also known as passive income. My family has set a goal to buy enough real estate and other cash producing assets to cover our yearly expenses. When our passive income is more than our living costs, we have achieved our goal of “financial freedom!”
  2. You can use banks’ money and government programs to get money to invest.
    1. A loan can be good or bad depending on your current situation, the loan terms (type of loan, interest rate, term, etc.), and overall financial goals. By leveraging (borrowing) money from banks, you spread some of the risk to them. If the bank loans you $80,000 for a $100,000 property, and the property value rises and you sell it for $150,000, you keep the profit! If the value decreases to $50,000 you are on the hook for $20,000 but at least you have not taken a hit of $50,000.
    2. In addition, by purchasing real estate with a fixed low interest rate loan, you have a hedge against inflation. As the government prints more money, the dollar has less purchasing power, inflation rises, and property values increase meaning it will require more dollars to purchase the same property in the future.
    3. Some people, such as Rich Dad Poor Dad author Robert Kiyosaki, warn against keeping long term debt in place because of how much interest you pay to the bank. Some people preach that you should leverage (borrow) as much money as possible and have the bank take most of the risk. This also allows you to purchase more properties.
    4. My preference lies somewhere in the middle. I am happy with accumulating moderate amounts of good debt (low and fixed interest rate) but I want to avoid bad debt (high and variable interest rate). I also want to make sure I keep enough reserves (liquid cash on hand) in case of emergency such as a natural disaster, tenant eviction, repairs, etc.
  3. Real estate investments have tax benefits that allow you to shelter your income and defer paying taxes.
    1. As a homeowner living in your primary residence, you can write off mortgage interest, property tax, mortgage closing costs (points), home improvements, and more.
    2. For rental properties, you can write off all of the above plus any other costs associated with the property including insurance, travel, home office, depreciation, and more. Check out this article on NOLO for top ten tax deductions for landlords for more information.
    3. Another interesting tax benefit for buying and selling rental properties is tax free exchanges. Simply put, you can sell your current rental property for a profit and avoid paying taxes on the profit by investing that money in a more expensive and lucrative investment property.
  4. Real estate can be an appreciating asset.
    1. Appreciation is an increase in the value of an asset over time. The population is growing and that adds to more demand for housing. If demand for housing outpaces building new homes, home values generally go up. In general, new building and development is currently not keeping pace with population growth and real estate demand. This concept is known as supply and demand.
    2. Beware, property can also depreciate in value as well. The chart below shows an estimate for San Diego home prices from 1987-2014. Over the long term you can see a general upwards trend (appreciation) but you can also see steep a downward trend (depreciation) during the bubble and recession of 2006-2011.
SDTrend

Source: http://www.jparsons.net/housingbubble/san_diego.html

I hope this quick and simplified introduction demonstrates some benefits of real estate as an investment vehicle. I personally like real estate as an asset for the reasons stated above and because people will always need a place to live, eat, sleep, shop, etc. This article is focusing on simple buy and hold investing, but the real estate industry is multi-faceted and there are many other types of real estate investments out there including wholesaling, fix and flip, buy and hold, trust deeds, notes, commercial property, lending, etc.

Stay tuned for part two of Real Estate Investing Basics where I’ll break down definitions and metrics for understanding how to determine what properties are the best for buy and hold investments.

Article by Matthew Burch, Feel Good Property Management Client Relations and Agent