Real estate may very well have generated more millionaires than any other asset class out there.
Because it provides multiple advantages that are unavailable through the typical investment vehicles most of us use. These advantages make real estate an IDEAL investment.
- I: Income Generation
- D: Deductions & Diversification
- E: Equity Capture & Equity Buildup
- A: Appreciation
- L: Leverage
These are the five biggest reasons I invest real estate.
I: Income Generation
One of my favorite aspects of real estate investing is the fact that it can generate tax advantaged income (cash flow) if done correctly.
If you buy smart, if you don’t overpay, if you use the right strategy, then the rental payments you receive from your tenants should exceed all of your expenses (mortgage, insurance, utilities, property management, etc.) including those that are hard to predict like vacancies, big repairs (new carpet, water heater, etc.), and capital expenditures (new roof, new porch, etc.).
Here’s the best part: you can pour all your positive cash flows into other investments that will accelerate and deepen your financial freedom!
D: Deductions & Diversification
Another reason real estate is an ideal investment is because it preserves your bottom line by enabling you to maximize your deductions all while diversifying your asset base and income.
Investing in real estate can significantly reduce your tax liability, which boosts your bottom line and magnifies wealth creation.
Reorder Your Cash Flow For Maximum Tax Efficiency
When you invest in real estate, you can essentially become a business owner, which allows you to reorder the sequence of your cash flow.
Here’s the typical cash flow pattern for most of us:
Here’s the cash flow pattern for business owners:
When you’re able to pay expenses before you cut a check to Uncle Sam, then you can significantly reduce your tax liability and keep more money for yourself.
Let’s look at a quick example.
Bob and Frank both earn $100,000 a year, spend $60,000 of it, and have a tax rate of 30 percent. The only difference between the two is that Frank is able to deduct his expenses before he pays taxes.
Here’s how that difference impacts their finances:
This is an overly simple example, but it demonstrates the point. Since Frank was able to deduct his expenses, he was able to keep almost 3 times more money than Bob.
Being able to reorder your cash flow and deduct business expenses before you pay taxes enables you to keep significantly more cash in your pocket.
This is one of the secrets the rich use to generate massive amounts of wealth.
Specific Deductions That Help The Most
Here are some of the specific deductions I use to reorder my cash flow, reduce my tax liability, and boost my wealth.
- Depreciation. Every year, for 27.5 years, I’m able to deduct a portion of my rental property. This is one of the most significant benefits as it is a non-cash deduction. In other words, I get to reduce my taxable income without actually having to spend any money. Normally, you have to spend a dollar to save a quarter or so on taxes.
- Home Office. I’m able to deduct a portion of the costs related to my primary home as a legitimate business expense. This means I can deduct some of my mortgage payment, utilities, insurance, repairs, and more to reduce my tax liability. I would incur all of these costs regardless, but since I’m an investor, I’m able to recoup some of what I spend.
- Mortgage Interest. I’m able to deduct the interest I pay on the mortgage I have for each rental property.
- Additional Office Deductions. I’m able to deduct the money I spend on office supplies and equipment including my cell phone, internet, computer, paper, and other supplies.
- Taxes, Insurance & Utilities. I’m able to deduct all of my real estate tax, insurance and utility charges for my rentals.
- Repairs. I’m able to deduct the money I spend on repairs and maintenance for each property.
- Business Expenses. I’m able to deduct typical business expenses like advertising, commissions, professional fees, and more.
- Mileage. I’m able to deduct the mileage I incur in my personal vehicle as long as I log the miles and they’re related to my business.
All of these deductions reduce my tax liability and enable me to stash more cash in wealth accumulating assets.
Investing in real estate enables you to diversify both your asset base and your income.
You’ve heard the old adage, “don’t put all your eggs in one basket.” In the financial world it’s called diversification. You want to hold a variety of assets to spread your risk around, so you can more easily survive the ups and downs of asset values.
Most folks invest nearly all of their retirement savings in the stock and bond markets where they have no real control of the asset values. That’s why there’s so much panic when the market drops.
One reason I love real estate is because you’re able to save money in a “real” asset outside of the over reactive stock and bond markets.
And as an added plus, you have significant control over your assets’ values. If you want the value of your property to go up, update the kitchen, remodel the bathroom, build a patio—you have control, not the wall street gamblers.
Real estate enables you to have significant control over the value of your assets all while deepening your diversification and helping safeguard against market volatility.
Real estate investing also enables you to diversify your income.
Most folks have one source of income—their job. And if they lose that, their financial world crumbles.
If you lose your job, you don’t want to lose your car, your house, or your family. You want to create multiple earning streams to ensure you can survive financial hard times.
Real estate helps provide that income safety net.
E: Equity Capture & Equity Buildup
As I said in the beginning, real estate has created more millionaires than any other asset class. A large reason why is because of the equity investors are able to capture and build over time.
Investors capture equity when they buy real estate at a discounted price. For example, my wife and I bought a house for $81,000 and it appraised for $119,000. We captured nearly $40,000 in equity overnight—not too bad.
Since real estate isn’t a “perfect” market, investors can take advantage of these discount purchases and add massive amounts of equity to their net worth.
Another way real estate investors build wealth is through equity buildup. A portion of every mortgage payment you make goes towards principal, which pays down the loan balance and gives you more equity in your home.
Here’s the cool part: as long as you have paying tenants, a portion of their rent check pays down your mortgage which builds equity for you every month.
Another benefit of real estate is the fact that it generally increases in value over time.
Over the course of the last 100 years, studies have shown that residential real estate has kept pace with inflation. In other words, on average, house prices have increased about 2 percent per year. Obviously, in some areas, appreciation has been much greater than that.
This appreciation allows investors to build great amounts of equity, which adds to their net worth.
And since real estate is an asset class we have significant control over, we can “force” appreciation. We can “force” an increase in value by remodeling, updating, or renovating.
When you borrow money to buy real estate, you are using leverage. Leverage enables us to make purchase and investments we wouldn’t otherwise be able to make. It gives us the means to produce more than we otherwise would be able to.
If we use leverage correctly, our investment returns will be magnified. If we use it incorrectly, it can be financially devastating.
Here’s how it works. Say you buy a $100,000 home, put 20% down, and get a mortgage for the remainder. Let’s say for the next 5 years your home appreciates by 2% per year, which means your home would be worth just over $110,000 at the end of year 5.
Here are the numbers:
So in 5 years, from appreciation alone, your annual Return On Investment (ROI) on the money you’ve invested would be 10% even though the underlying asset only returned 2% per year.
That’s the power of leverage—it has the power to magnify our returns. But beware—it also has the power to magnify our losses.
If done correctly, real estate can be an IDEAL investment. It can boost your income, reduce your tax liability, deepen your diversification, create massive amounts of wealth, and magnify your returns. Real estate is a great tool to expedite your journey towards financial freedom.
Here are the 5 reasons I like real estate investing:
- It generates income for me to use now
- It enables me to deduct expenses and reduce my tax liability all while deepening my diversification
- It generates wealth by creating equity
- Overtime, it appreciates and adds to my net worth
- I’m able to use leverage to magnify my returns
Seriously consider investing in real estate to generate wealth. It’s not for everyone. It requires more work and more stress than the other passive investments I use.
Make an action plan of how you can add it to your portfolio.
Take action and buy a small, inexpensive rental property.
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