I love talking about investing in real estate with new or first-time investors in Oakland. What’s cool about real estate is that it nearly always fits investors’ goals and should become part of an investment strategy. It’s usually some combination of five main reasons: cash flow, appreciation, equity, leverage, tax benefits.
Real estate as an investment often produces income through rent. After subtracting expenses and mortgage payments, you’re left with cash flow. It’s a good thing. I love it and you will too.
Appreciation is the increase in value. This is where much of the wealth in real estate is built. There’s an old saying about buying land because it’s the only thing they aren’t making anymore, and while there are arguments against that blanket statement, it’s a valid point in many parts of the East Bay. With the bay, protected lands, and plentiful access to economic hearts of our region, our geographical constriction forces upward pressure on prices.
Equity is simply the value of the property minus the debts owed against the property. In a rental property, not only do you have income paying your expenses and potentially producing cash flow, but the income is also paying down the principal balance on your mortgage. This creates wealth through building of equity even if the property value holds steady.
Leverage might be my favorite reason to buy real estate over other investment vehicles. It’s the overlooked underdog. Essentially leverage is the ability to borrow against a property and bring less than 100% of the purchase price in cash or downpayment. If you have $250,000 lying around, you can invest in roughly $1,000,000 in real estate, which allows you to participate in the appreciation on the full $1,000,000. You may be able to use leverage with other investment vehicles, however real estate is the most accessible.
To illustrate the power of leverage, imagine investing in an asset that appreciates at 5% with $250,000 in cash. In many traditional investments, you’re earning 5% on $250,000 or $12,500. If you’re using leverage to buy real estate with the same $250,000, you’ll be earning 5% on $1,000,000 or $50,000. Personally, I like the second option better.
I love write-offs. I can write off travel to my properties, all the maintenance, repairs, mortgage interest, and other expenses for my rental properties. I can also write off the value of the parts of the property with limited life… such as the structure itself. This is called depreciation and can lead to huge tax savings.
For example, if you had a $500,000 property of which 70% of the value can be said to be in the structure itself, you may be able to take a depreciation deduction of $350,000. This is often spread out over 27.5 years, which means an annual deduction of $12,727.
Not tax advice; talk to your CPA.
Do you have a favorite benefit of investing in real estate? I’m a huge fan of them all and struggle to pick a favorite. Which is just fine considering that any good investment is going to deliver on all five. Though for the first two–cash flow and appreciation–you’ll typically see they have an inverse relationship. If you see high cash flow, you’ll likely experience low appreciation and vice versa.