Real Estate Investing - The Big Picture
In this article we cover the basic concepts of real estate investing.
50,000 Foot View
The goal of investing in real estate is to buy a property where the monthly rent is sufficient to pay all the recurring expenses (debt service, taxes, insurance, management fee, maintenance, etc.) and have money left over which comes to you as illustrated below and is referred to as cash flow.
How Do You Buy an Investment Property?
One of the biggest advantages of real estate is long term fixed rate financing. Because of the ability to finance, you can add a large asset to your portfolio for a fraction of the actual cost of the property. The most common financing investors use is 20% down, fixed rate, 30 year financing which is illustrated below. For example, the down payment on a $200,000 property is $40,000. There are additional costs involved with buying and placing a property in production, which are discussed in another article on Time, Money and Risk.
Taxes and Cash Flow
Tax advantages of investing in real estate include the ability to deduct almost all acquisition, recurring, and maintenance costs plus depreciation. Depreciation is a wonderful feature of real estate. Depreciation is an annual allowance for the wear and tear, deterioration, or obsolescence of the property . Despite the fact that real estate typically increases over time the IRS views rental real estate much as it does machinery (drill, grinder, fork-lift, office furniture, etc.). The IRS concept is that machinery becomes less valuable over time due to wear and tear. For example, the IRS guidelines state that the "useful" life of office furniture is 7 years. Another way of saying this is that the office furniture loses 1/7th of its value each year. And, you are allowed to deduct this "loss" from your income.
The same is true for investment real estate but in this case the IRS defined the useful life for most real estate is 27.5 years (why 27.5 years?). Simplistically, the only major difference between depreciating office furniture and real estate is that you can only depreciate the “improvements” (structures and such), not the land. For example, if we assume that 80% of the total purchase price is depreciable improvements (Or, 20% of the purchase price is the cost of the land) and we paid $180,000 for the property. You would then deduct ($180,000 x 80%)/27.5 or about $5,236/Yr.
After subtracting depreciation from income it is not uncommon for a property to have a positive cash flow while at the same time generating a tax loss! Below is an illustration showing the cash flow (rent - expenses) and the tax loss (rent - expenses - depreciation).
Note: How losses are actually handled is more complex than what we described above but the concept is correct
Good investments pay for all recurring expenses including the mortgage (debt service). When the mortgage is paid off, the cash flow significantly increases as illustrated below.
The concept of purchasing investment real estate is relatively straightforward. You make money by purchasing properties such that the rent it commands exceeds its recurring costs. Investment real estate tax advantages can generate a positive cash flow while at the same time generating a tax loss. Once the mortgage is paid off, cash flow increases significantly. Real estate investments are near perpetual income streams.
Want to know more about investing in Las Vegas real estate? Contact us today. You will be glad you did.
Eric Fernwood, Realtor | 702-358-8884 | EricFernwood@gmail.com
Cleo Li, Realtor | 512-296-0425 | CleoYLi@gmail.com
Vegas International Properties Group (VIP Realty Group)
7570 Norman Rockwell, Suite 140
Las Vegas NV 89143