Overview of real estate investment

Hello and welcome to my blog on great financial investments.  This series coming up is going to discuss real estate as a financial investment, and great one at that. But first a little background.  I am a small time real estate investor…  for now.  I have 3 residential rental properties with partners around where I live in suburban Chicago area.  Two of them are townhomes and one is a single family home.  I’ve had great results from all three in the 5 years that I’ve owned them.  

In all honesty, they started out as fix n flips (where you buy a property, fix it up and re-sell it for a profit) but we couldn’t get the price we wanted in selling so we rented them out (nice to have options).  We sold one for a healthy profit and bought another one and held that one.  They have all been rented out since with 2 of them having the same tenant for the last 5 years.  That consistency is great as it is less time you have to spend getting a new tenant.

Now I manage them but they take very little effort.  This will happen if you find a good tenant.  A good tenant is defined as one who pays in full and on time each month, takes good care of the property and requires little to no attention from you.  If you find one, hold on to them because they are going to make you some great money over time.  

A few keys to making real estate work as an investment:

  1. Management – This is so critical because management makes the decisions that make or break your investment.  I manage my own right now because I know how to make them work.  Listen up: No-one, I repeat no-one, cares as much about your investment as you do.  Remember that!  If you hire out management, make sure you do your research and keep a very close eye on them until you’re comfortable with their level of care and competency in managing your investment.
  2. The numbers – You have to run your numbers before you buy to make sure that all your expenses total less than the rent you’ll be bringing in.  Some financial advisors recommend running at a loss as a tax advantage but why would you do that if you can be cash-flow positive?  Be smart and know your numbers before you buy or else you may wind up losing money every month.
  3. Tenants – This factor is critical as I’ve said.  But how do you get good tenants?  Follow this: If you buy a D (think grades) property, in D condition in a D location, you’ll attract D tenants.  If you buy an A property, in A condition in an A location, you’ll attract A tenants.  I learned this the hard way as my first investments were 100 year old houses in disrepair in poorer neighborhoods.  Bad tenants,  tons of repairs and negative cash flow.  A hard lesson for sure but now I know and I’m telling you.  Think about it this way: Would I feel comfortable moving my mother into this house in this neighborhood?  If not, it’s probably how your prospective tenants feel.
  4. A big shout out to our sponsor of the day, Fort Worth Plumbers, a plumber Fort Worth residents can trust!

Benefit of Real estate – Total benefit

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.  Speaking of investment, special thanks to today’s partner, Houston Plumbers, a truly great plumber Houston Texas relies upon.  We appreciate you support.

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 often called “phantom cash flow” because it often isn’t taken into acccount and goes largely unnoticed.  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.  You, as an investor in real estate are able to depreciate the property, not the land.  On top of that you are able to depreciate appliances you offer to tenants over a shorter amount of time.  All this adds up to fantastic tax savings.  

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. A special thanks to our supporter of the day, Philadelphia Plumbers, a top notch choice for a plumber in Philadelphia, PA

Benefit of Real Estate – Appreciation and mortgage reduction

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.

Special thanks to our sponsor of the day and a fantastic plumber Arlington Heights has full trust in, Arlington Heights Plumbing.  We couldn’t keep up this great content without you!

Benefit of Real Estate – Cash flow

Cash flow

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 Palatine Plumbing.  They’ve served us well for years and are a fantastic plumber Palatine residents have grown to trust.  

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 as well as I build my case for real estate being a great way to earn great riches.