The successful real estate investor never makes a real estate investment because it’s romantic. Real estate is not purchased, held, or sold on emotion for it’s neither love nor beauty that compels. As one real estate investor put it, “Only women are beautiful.”
Real estate investing is about the return on investment. And real estate investors trying to decide whether there is a potential benefit to purchase, hold on to, or to sell rental income property rely on four basic returns inherent in real estate investment property to make that decision.
Understanding these investment decision basics, where they come from, and how to calculate them is what fuels real estate investment success.
1. Cash flow. All real estate investment property ebbs and flows with a stream of money coming in from rents and other income, and money going out for operating expenses and debt service (loan payment). Cash in minus cash out results in cash flow. When more cash comes in than goes out the result is positive cash flow, and when more is spent than received the result is negative cash flow.
The goal of course, especially for the small investor without deep pockets, is to be sure the property always produces enough cash to pay the bills. Before making the investment, prudent investors should always run the numbers and look for the benefit of positive cash flow.
2. Appreciation. Another benefit of real estate investment is the tendency for real estate to grow in value over time in what is known as appreciation. Future selling price minus original purchase price equals appreciation. Straightforward enough, but smart real estate investors don’t leave appreciation to chance–they follow the income stream.
Smart investors understand that other real estate investors buy the income stream of rental property (as they do). The more income stream they can sell, therefore the more they can expect their property to be worth; the faster they can increase the income stream, the sooner the property will most likely appreciate.
Thus, successful real estate investors consider market and economic conditions, physical improvements, and operating expenses to determine the likelihood of increasing property value. The result of a favorable location, a positive shift in supply and demand, a good probability to demand higher rents or lower vacancies, or an opportunity to reduce wasteful expenditures are all issues that could effect appreciation and are carefully considered by thriving real estate investors.
3. Loan Amortization. Amortization means to reduce periodically and hence, loan amortization suggests a periodic reduction of the loan over time. Therefore each time tenants pay the rent they provide cash to pay down the debt and benefit real estate investors by virtually helping them to buy the property.
4. Tax Shelter. Real estate investment also provides an investor the benefit of being able to legally reduce annual or ultimate income taxes.
As a general rule, most costs incurred at the time of purchase are deductible in the year of purchase. All expenses you incur in the operation of the property are deductible. The IRS allows you to deduct the interest you pay on your mortgage. The IRS also assumes that your buildings are wearing out and becoming less valuable over time and therefore allows you take a deduction for that presumed decline in what the tax code calls cost recovery (i.e., depreciation).
Of course there are nuances and exceptions in all tax matters, so real estate investors should always check with a tax expert to be sure what the current tax laws are for the investor in any particular year.
Successful real estate investors are a testament to the benefit of making money with real estate investment property. You can benefit, too. Just be sure to run the numbers, either on your own, with good real estate investment software, or with the help of a real estate professional. Remember, real estate investing isn’t whimsy, its business.
Best of all, real estate investing is profitable when it’s done correctly.
About the Author
James R Kobzeff is an active real estate broker and developer of ProAPOD Real Estate Investment Software – ProAPOD Real Estate Investor Software – real estate investing solutions that put rental property analysis at your fingertips!