For the most part, the fact was that the “gurus” made their money selling books and tapes! Few had real experience to make it in the real estate market. Many of the most famous and most visible of these filed bankruptcy more than once! However, many of the things they taught were truthful, and some apply more today than they did back then.

Real estate is indeed a good investment and can be a significant part of your financial well being. You must, however, have a plan. Many who made real estate purchases based on the recommendations of “gurus” found themselves in unwanted situations, much to their dismay! Hopefully, you don’t know anyone who has had any of these situations.

We invest our resources in the anticipation of receiving some financial benefit for those dollars. Investment real estate is generally bought for one reason, financial benefit (If you know of another reason, please tell me). The purpose of this article is to evaluate the different benefits of investment real estate and apply those benefits to the objectives of the investor. In the ‘70s and ‘80s it was possible to make a mistake and wait for inflation to bail you out. Today, that would be a long wait.

What are the benefits that make real estate the I D E A L investment?

I = Income

D= Depreciation

E= Equity Build Up

A= Appreciation

L= Leverage

As we will see, these benefits may work independently or in harmony to achieve real estate investment goals. The specific benefit that you are seeking will give greater emphasis to some parts of the formula and less to others. It should be mentioned also that the use of these to avoid taxes and increase our net worth dramatically!! Let us proceed with Income!

I = INCOME

Please allow me to introduce you to our friend IRV.

IRV is an acronym for Income, Rate of Return, and Value.

The formula looks like this: I / R x V

If you know 2 of these, you can solve for the third. Should you consider an investment, apply this formula to see if the proposed investment meets your requirements.

First, look at the NOI (Net Operating Income). That is what is left of your income after all expenses. Apply the Rate of Return you require for your investments to that number and you will know the value of that investment to you. For example, a 4-plex that has a NOI of $7,124 per year, can be worth $90,000 to someone looking for an 8% Rate of Return, and $71,250 to someone looking for a 10% Rate of Return, and $59,000 to someone who is looking for a 12% return.

The formula is (I/R=V). Other applications are (VXR=I), and (I/V=R). The value of these calculations is in the reliability of the Net Operating Income figures. If you do not properly calculate income and expenses, you will not get an accurate representation of value. However, if you make a thorough investigation of the property data and verify the accuracy, IRV will establish a solid foundation for your valuation of a particular investment property.

Many investors do not look at expense items such as management, maintenance, and vacancy as being applicable to their investment. This increases the NOI on the property and may cause the investor to pay more for the property than is warranted. Such expenses should be factored into your calculations even if you do not pay them on a current basis. Even though you do the work yourself, the work has value and the price of the investment should reflect that fact.

NOI can be calculated by using the APOD (Annual Property Operating Data) form included in this booklet. Please use real numbers. Check the income and expense report for the investment you are considering and verify as much as possible these figures. Get accurate information of what the taxes and the insurance will cost. Credit and vacancy should be estimated based on the best information available from management companies, ads, etc. Repairs will be estimated from looking at the condition of the property. Remember to be accurate!!

D = DEPRECIATION

Depreciation is the non-cash expense part of the real estate equation. It is taken on the part of your investment that is not land. Land does not depreciate, but all improvements do. IRS rules allow you to expense the “wearing out” of the asset over the life of the asset. So, if you pay $32,000 for a rental property and the land is worth $4,500, then you would have $27,500 to depreciate. Current IRS rules state that the residential rental property must be depreciated over a 27.5-year life span. Do the math and you find that you can deduct $1000 per year on your 1040 Schedule E as an expense, even though you spend no money! Obviously, if you had $275,000 in depreciable real estate, you would have $10,000 to deduct. That can make a nice break in taxes due. Be aware that you should check with your tax advisors for current limitations on deductions according to your current situation.

Current tax brackets are in the 15% to 33% range; the benefits are not what they used to be when depreciation limits were 15 to 18 years and tax brackets were as high as 90%. As they say, all good things must end. Maybe that will go for all bad things as well.

On the other side of this gift from Uncle Sam is pay back time. IRS lets you take the expense every year on your property. However, that expense reduces the BASIS in the property. The $32,000 property above has a depreciable basis of $27,500. If you own that property ten years, you would have depreciated that property by $10,000 leaving your basis at $22,000. If you then sold your property for $42,000, what would your gain be? If you said $20,000, you are correct. You must subtract your BASIS from the sales price, not what you paid for the property. You must recapture the depreciation. That means you pay taxes on your gain now.

E = EQUITY BUILD UP

Equity build up is the “silent saver”. Each mortgage payment you make is separated into principal and interest. It is the principal part that makes your net worth grow, because it is savings that you can’t withdraw!

This part of your investment plan can often be overlooked. It is not as glamorous as a big positive cash flow. However, over time, it can be a powerful part of your wealth accumulation. For example, when you purchase a new property, consider different ways to structure your financing for equity build up. Will the owner of the bank give you a better interest rate for a quicker pay out? Let’s look at a $10,000 loan and see how different payouts can affect our equity build up. Assume a ten percent interest rate for different payout periods.

Months Pmt Principal Interest

360 $87.76 $4.43 $83.33

120 $132.15 $104.37 $27.78

60 $212.47 $198.59 $13.89

As you can see, we can have more cash flow or less cash flow. Now we have to apply our investment objectives to the equation. As a younger person, you might benefit more from the 30-year financing. You get more current income and less equity build up. As a person more advanced in your investment program, you might consider giving up current income in order to have the property free and clear in a shorter period of time. Your investment goals will determine which is the best approach for you.

A = APPRECIATION

Appreciation is every property owners delight! It is an increase in your net worth that is not taxed. At least not yet. When the value of your property increases, you have experienced appreciation of an asset. It does not matter what caused the appreciation, you get the benefit. So how do we achieve this desirable circumstance?

1) Inflation. The effects of inflation are well known and documented. When too many dollars are chasing too few

goods, when there is less supply than demand, prices go up. And they go up across the board. If you remember the 70s and 80s, there were many years that prices increased in the double digits. Those who owned assets experienced an increase in net worth.

2) Forced appreciation. William Nickerson taught this in his book “How I turned $1000 into Five Million in Real Estate”. By improving the property and increasing the rent, you force the property to increase in value.
(See the IRV discussion).

3) Neighborhood. Location, location, location. If you know the paths of progress, you can often benefit from an appreciation of the location. As an area becomes more desirable, the price goes up. By that same token, a location could experience negative growth.

4) Buy low. Obviously if you can buy a property at below market value, you have just had appreciation. A $100,000 property that you buy for $80,000 just gave you an increase in net worth of $20,000 tax-free dollars!

L = LEVERAGE

A lever is a tool that used properly can help you achieve great results. Leverage in Real Estate involves the use of OPM (other people’s money) to help you reach your goals. In the event you had to use all cash, all the time, real estate investments would be available to few. There are many ways to use current resources to leverage your way into profitable investments. Your good credit is a lever that may allow you to partner with someone who has a great opportunity but has more than his allowed number of loans! You furnish the credit to make your partner’s deal work. Your handy man skills can be traded as down payment on a property. Veteran’s benefits can get you a duplex for no money down. Personal property such as cars, jewelry, boats and a lot more can leverage you into investments.

For many people, buying a principal residence is a terrific first choice for real estate investment. A small house or duplex in the $100,000 to $125,000 range will provide shelter and offer investment benefits at the same time. Current availability of 100% loans for principal residences makes it easy to leverage into a home of your own. With little or none of your own money you can control a major asset. Once you control the asset, managing it is critical. Getting the maximum return makes your net worth grow at a disproportionate rate for the amount invested. For example, remember A=Appreciation? In the event the house increased in value only 3% a year, that increase is based not on how much money you put down, but on the value of the asset you controlled!! In other words, you just added $3000 to your net worth! Not a bad return.

Now for the best part. When you sell your personal residence, and you have lived there at least 2 of the last 5 years, any profit you make is tax free up to $500,000 for a married couple. (IRC Sec 121).

You may also use a personal residence to get started on a leveraged plan of investing by not selling but renting that residence when you buy another home! The idea is to control assets and reap the benefit of untaxed earnings. Does leverage have a downside? Yes. It is called payments. The more you leverage, the higher the payments. If the money spent exceeds the money coming in, the property is called an “alligator”. Alligators eat. These kind eat your $$$$’s. Do not kid yourself about income and expenses when you are borrowing money to buy real estate. That has caused many investors to lose sleep; trying to make payments with no money coming in and no cash reserves.

Leverage can help your overall investment program, but it can also be your downfall in the event you do not plan and carefully implement your plan. Make a written list of income and expenses BEFORE you buy any rental property. If the income is not sufficient to cover all costs and put back a little for reserves, then you need to take a closer look at the leverage. Maybe put a little down to reduce the payment. Or perhaps seek a lower interest rate before you commit to purchase. Maybe commit some of your current income to the property, if the deal is good enough.

CONCLUSION

Altogether, real estate is the IDEAL investment. The biggest decision is what makes it ideal for you? What are your needs and goals? What resources do you have available to help you reach these goals? How can these resources be applied? The answers to these questions can help you focus on the best path and plan for your investment program.

One of the best explanations of financial plans is as follows:

You are You plan

Here to be here

*________________________________________________*

Number of periods to accomplish goals

N %I PV PMT FV

Financial planning is a matter of determining what PV (present value) you have to use, PMT (payment) that you can add to PV, the %I (interest rate) you can apply, and N (number) of periods to wait, and applying all these to get to the FV (future value) that you want to achieve.

Once you have determined what it is you want real estate to accomplish for you, your education begins. Now you must learn about management, maintenance, accounting, taxes, leasing, and the other responsibilities of being a successful investment property owner. In order to be a successful property owner, you must stay up to date on the changes in the laws and the requirements that go with owning real estate.

Failure to plan for your goals and to educate yourself for their accomplishments can cause serious harm to your financial well being. That is why you need access to those who can competently advise you on accounting, legal, and other professions pertaining to your investments. You would be surprised at how many investors never consult with anyone!

Thinking about Investing in Real Estate, ask a professional….contact us at Venture Investments or call us at (704) 405-9079. We have a dedicated Investment Director whose sole duty is to search for investment properties that have instant equity in them. To make sure you are protected, we disclose everything we have access to so you fully understand and are educated about the property before you invest. We provide access to information that only just professionals investors know about buying and selling investment properties.

Contact John Turner with Venture Investments today and let’s get started.

prepared by John Turner.
author “unknown”