With summer coming on soon, and the heating up of real estate markets along with the weather, it’s a great time to talk again about the business of real estate investing. Sometimes we get so deep into the weeds we can’t see the big picture. When compared to other businesses that the individual can start from home, you simply can’t do better.
In most other businesses you need office, retail or manufacturing space. Phones, equipment and other related overhead expenses make startup expensive. Real estate investing is ready to go as a business with stuff you already have; kitchen table, smart phone & computer. It’s a zero-dollar startup.
Yes, you may be wholesaling and/or buying and selling real estate, but you’re not holding it in stock hoping a buyer comes along. Wholesaling moves the product as quickly as you can close on one deal and get to the closing table for the next. If you are holding inventory, meaning rental property, it is paying you. The cash flow is going into the bank every month. Fix & flip extends your holding time a bit, but you’re likely using transactional funding to get the deal from purchase to sale.
You run your own show, and you do not need the expense or hassle of employees. Sure, others are involved in your success, but they’re contractors, title companies, insurance agents, etc. They have their own businesses and you just utilize them as needed.
Unlike stocks and bonds, real estate is resistant to inflationary risk. The short term strategies like wholesaling and fix & flip are over and done too quickly for inflation to be a factor. Rental property investors are subject to price inflation for goods and services, but there are other factors or actions to reduce or avoid negative effects:
- If home prices are rising, so is the value of their rental investment.
- Rising costs for taxes, insurance and maintenance can usually be offset with rent increases, especially when home prices are rising. Tenants are seeing rents rise everywhere when inflation is a problem.
Returns from the stock market and bonds are usually hurt by inflationary trends.
Well, at least to a degree, falling home prices do not take investors under. Sure, in the 2006 market crash, the speed at which the market collapsed took down many short-term investors holding houses they expected to sell quickly that now were in losing territory. However, rental investors simply took the devaluation of their properties in stride. In fact, people losing their homes to foreclosure needed homes, so rental demand began to rise. Rental investors simply held onto their portfolio, reaping cash flow, and waited until values recovered.
Variable Cash Requirement
The beauty of real estate investment is that you can start out without a pot full of cash and get a great business going. Starting with wholesaling, the short-term investment of just a small earnest money deposit will get the deal done. As you get deals done, you can build the cash necessary for rental investment down payments if that’s your goal. As for financing fix & flip deals, there are transactional lenders ready to fund them.
Real estate investment enjoys tax advantages not available to stock and bond investors. There are a number of very lucrative tax breaks, especially for long-term rental property investors:
- Deductions for:
- Real estate taxes
- Mortgage interest
- Property insurance
- Costs of acquisition
- Maintenance expenses
- Marketing expenses
- Another deduction that deserves special mention is the depreciation deduction. All of those in the list above involve deductions for money you’ve spent in the tax year. Depreciation involves not an extra dollar out of your pocket, but puts money back into it. The IRS allows depreciation of the structure (not land) of a rental property over 27.5 years. This means that a home with a cost/value of $200,000, will get an annual depreciation deduction of $7273 ($200,000 / 27.5). This is offsetting income from the rental, so puts tax dollars back into your pocket.
- The 1031 Tax Deferred Exchange allows you to sell an investment property at a profit, roll the profits into another property while avoiding capital gains taxes in the year of the sale. You can do this over and over as you grow your portfolio and wealth.
Hopefully, this has been an enthusiasm refresher, as real estate investment is still one of the very best, if not the very best, paths to building wealth.
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Enjoy this wisdom and have a great week!