Among the many benefits of real estate investments are Income, Depreciation, Equity, Appreciation and Leverage.
One thing for certain in real estate investing is that different investors have different investment criteria in terms of what they are looking for in a real estate investment. There are investors that buy for cash flow. There are investors that are looking to park money for appreciation and bank on rent growth. There are investors that are looking to buy, renovate and quickly flip out of that investment.
If you are starting out, a great (and simple) place to start when evaluating the benefits of real estate investing is to refer to the old real estate acronym I.D.E.A.L.
Income
If you are buying investment property, at the very least that investment should produce some income in the way of cash flow. On a very basic level, here is how that works. Let’s take the following example for a multifamily property.
$1,000,000 Purchase Price
$80,000 Annual Gross Rents
($32,000) Annual Expenses
$48,000 Net Operating Income
($36,000) Annual Mortgage Payments
$12,000 Annual Cash Flow. Assuming you put down 30% and financed 70% that is about a 4% cash-on-cash return.
Depreciation
Real estate has many incredible tax benefits, but one of the best tax benefits is depreciation. Simply put, depreciation is a non-cash expense (effectively a tax shield) whereby an investor can shield from taxes most or even all of the rental income generated by this particular real estate investment.
Depreciation allows investors to spread out most of the cost of real estate purchases over a period of 27.5 years (for residential buildings). If you own a multifamily property and you have been utilizing the depreciation tax shield for over 27.5 years, you may consider selling as you will likely be paying significant taxes on your rental income. Once your property is fully depreciated, it may be tax-inefficient to own this particular investment property.
Equity
As you continue to make mortgage payments towards your investment property, you will continue to pay down the principal balance of your loan. As a result, the longer you own investment property, the more equity you will continue to accumulate both from the principal reduction and appreciation of the property itself.
Appreciation
Over the long run, real estate prices and rent tend to appreciate (i.e. increase in value) at a rate somewhat akin to inflation (~3-4% per year) – sometimes greater in core markets like Los Angeles. This is known as passive appreciation. And while it might not sound like much, when combined with the other benefits and when compounded over long periods, passive appreciation can build enormous wealth.
On the other side of the appreciation coin, is active appreciation. Active appreciation is achieved by actively putting a plan in place to increase the value of your property. In Los Angeles, and in particular with Rent-Controlled properties, this may come in the form of offering cash-for-keys (aka tenant buyouts) for lower paying tenants. Once those units are vacated, many investors will allocate capital towards renovating these units in order to achieve at or above market rents.
Leverage
Most real estate transactions are acquired using leverage (or loans). The power of leverage cannot be understated in real estate. Taking the example above, you can put 30% down and control a $1M asset. Leverage can significantly amplify the returns on your cash invested. But on the flipside, leverage can also magnify your losses significantly should the market go south.
