If you have the means, invest in real estate.
You’ve likely heard something similar to this statement before – and for a good reason. Real estate offers the potential for excellent returns, a stable and predictable income, and an avenue for diversification.
If you want a deeper understanding of why investing in properties can help you reach your financial goals, this article will detail the four ways of making money by owning real estate.
Cash flow primarily applies if you are renting out the property you own. Basically, cash flow is determined by the profit you gain from a rented property after subtracting your costs and operating expenses. These costs can include mortgage, taxes, property management, insurance, repairs and maintenance, landscaping, and administrative costs.
If, for example, you are spending $1200 on the expenses mentioned above, and you are earning $2000 in rental fees, you have a net cash flow of $800.
Cash flow is excellent because it’s passive and continuous. Near-term cash flow is typically pitted against long-term appreciation. The former puts money in your hands right now. And while the latter has the potential to be more lucrative, some prefer a bird in the hand.
Although there will be years of decline and fluctuations, real estate value still generally tends to increase over time. This is especially true in cities and up-and-coming neighborhoods where demand is high.
According to the Federal Reserve Economic Data, the average sale prices of houses in the United States have increased from below $40,000 in the ‘60s to more than $400,000 in 2020.
Because of this trend, many choose to invest in real estate with the intention of holding on to the property until it appreciates in value and can be sold for a significant profit.
There is also something called forced appreciation, where the property owner improves the property so that its value increases. This usually involves renovations and upgrades to the property.
For landlords renting out their property, appreciation of the market value can justify an increase in monthly rental fees.
Depreciation here does not mean that you can make money off of the reduction in the value of your property. It has to do with one of the many tax breaks and deductibles you can take advantage of as a real estate investor.
Basically, property owners can get an income tax deduction based on the perceived decrease in value of rental properties due to wear and tear over time. Although this is not typically the case, the IRS allows owners to lower their overall tax liability.
This is calculated using the actual value of the building, divided by the number of years or the ‘useful life’ of the property determined by the IRS, which is considered to be 27.5 years.
A property that has a physical structure valued at $350,000, for example, can help the owner get a tax break of $12,727 each year. Furthermore, if a significant renovation is undergone, a cost-segregation study can allow the real estate investor to accelerate depreciation of certain renovation costs.
Properties are usually acquired through amortized loans. Monthly payments typically go to pay for interest and whittle down the principal amount owed. While the principal goes down, your equity in the property goes up.
If you rent out your property, the monthly rent essentially pays for that property little by little.
It would be very unlikely to hear advice against investing in real estate because of its promise for profit and financial freedom. Understanding the actual mechanisms that earn you money in real estate helps you take advantage of these opportunities.
Take note of the items mentioned here to secure a profitable future in real estate investment.
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