I believe that investment real estate, when purchased wisely and taken care of properly, has the potential to make almost anyone wealthy over the long term. Investment real estate is powerful because of the way it is taxed, the way it can be financed, and how easy it is to improve.
The best part about investment real estate is that it can be purchased with the bank’s money. Let’s say a duplex down the street is for sale for $150,000. How much money will you need to purchase the property? If you said $150,000, you would be wrong. You only need to come up with 20 or 25 percent of $150,000 or $30,000 to $37,500. Now all you need to do is find a bank to lend you the rest. If one bank happens turns you down, just walk down the street and find another.
This 20 percent down payment makes you 100 percent owner of the investment and any subsequent increases in value. Let’s say the property increases in value by 3 percent or $4,500 during the year. Your return on the investment is not 3 percent, but is instead a whopping 15 percent ($4,500 divided by your $30,000 down payment). Your return is magnified by the fact that you used other people’s money or leverage to purchase the property.
The tax code is kind to real estate investors thanks to the depreciation expense. Each year, the IRS allows a real estate investor to expense a portion of the cost of the building. In the above example, the person who purchased the $150,000 duplex can expense approximately $4,400 of the cost each year. This is what I like to call a “paper” expense because it only exists on paper. There is no $4,400 actually coming out of your pocket during the year. In fact, the property, if purchased properly, should generate an annual positive cash flow and this depreciation expense can help shield the investor from paying any taxes on the cash.
Investment real estate can be easily improved by the investor. If the $150,000 duplex above doesn’t have a garage, you could build one or have a contractor build one. The garage might cost you $10,000, but now the tenants are happy to pay you an extra $50 apiece per month to have their vehicles protected. Your $10,000 investment is generating $1,200 per year. Adding a garage is just one example of an improvement that can generate a nice return on your real estate investment.
The above is a summation of complex tax law. Please check with your tax professional before making a decision. Our CPAs at Milliken, Perkins, and Brunelle are available to assist you any time of year.