Why Invest in Real Estate?


 

  

 

Here are five good reasons

 

1.         Leverage – This is the ability to use borrowed or OPM (Other Peoples Money) to work for you. Leverage allows you to magnify the return on your investment. There is more leverage available in Real Estate than any other investment, and the leverage or borrowed money is secured by the property being purchased. In most cases there is no personal liability for the loan. To illustrate how leverage works look at the two case studies below.

 

        1) Assume you purchased a rental property for $150,000

             25% down payment = $37,500 (Equity)

             75% 1st mortgage   = $112,500 (financing/leverage)

 

Lets say the property rents for $1,000/mo.  =   $12,000/yr      (Income)

 

"       "      " mortgage payments are $623/mo.   $7,472/yr

"       "      " Taxes are                                         $1,500/yr

"       "      " Maintenance is              $50/mo.      $600/yr

                                                                           $9,572/yr     (expenses)

 

                                                                           $2,428/yr     (cash flow)

 

So the cash return on your investment of $37,500 is   $2,428

                                                                                    $37,500   =  6.5%

 

However, the mortgage is being paid down every month and at the end of the first year the mortgage paydown is $2,507 - so the return on your equity is 

                                                   $2,507 + $2,428 = $4,935

                                                                                 $37,500  = 13.2%

 

2) Same property without the benefit of leverage  - the return as follows;

 

                                                $150,000    (equity)

 

                                                $12,000     (income)

                                                $2,100       (expenses)

 

                           cash flow is   $9,900

                                               $150,000      =  .67%  total return

 

Let's say after 5 years you sell the property and it is now worth $175,000

"        "  the rent and expenses have stayed constant but the mortgage has been payed    down by $23,630 - so the return on your initial investment of $37,500 is ;

 

      cash flow (5yrs) $12,140 + mtg paydown $23,630 + appreciation $25,000

                                       =  $60,770

                      $37,500  = $162.1% total return

 

Without leverage- cash flow is $49,500 + appreciation $25,000

                    = $74,500 

                      $150,000 = $49.7% total return

 

                                                                                                                                                                             

2.        Tax Benefits – Tax incentives for Real Estate Investors far exceed other investments. The greatest tax benefit in Real Estate is the capital gain treatment of 50%. This means that half of your gain is tax deductible. This does apply to other non-registered investments as well. Some other benefits that may not apply to other investments are; Capital cost allowance (CCA) or the ability to depreciate the property, and thereby defer the taxes until the time of sale. The interest on the mortgage is also tax deductible, and all your expenses associated with the property such as property taxes, repairs and maintenance, property management fees, insurance, advertising, utilities (assuming the tenant doesn’t pay them), and any other expense related to the property.

3.        Versatility – Real Estate is by far the most versatile investment you can make. A single property can provide you with many different options such as Cash Flow – or the properties ability to provide you with income on a regular basis. Appreciation – the properties ability to increase in value over the long term or the short term. An example of this would be buying below market value (ie; a Seller is desperate, foreclosure, divorce, absentee landlord (vacant property) etc. Improve & flip – being able to buy distressed, or neglected properties and do repairs and improvements and re-sell for a profit.

4.        Imperfect market – Most Real Estate prices are not fixed and therefore there are great opportunities for the investor. Not only can property be acquired below market value, but other incentives are also available –ie; Seller financing – this allows an investor to buy with very little or no money of his own. The Real Estate market is also open to any and everyone. Whether you have lots or little money, good or bad credit (mortgages in Alberta can be assumed without qualifying).

5.        Added value – There are many ways to add value to a property. Physical improvements – this could be as simple as painting, replacing flooring, changing light fixtures, hardware replacement (door knobs, cupboard handles etc). These improvements are considered cosmetic and are very cost effective. Larger improvements would be items like; shingle replacement, new furnace, vinyl siding, windows, basement development, addition, new garage. These improvements are more extensive and usually do not have an immediate pay back so the investor needs to be careful on what improvements are done and when. Over time all improvements, if done properly will add value to any property. Change use – all properties have what is called a highest and best use. This is a term used by Real Estate Appraisers when valuing property. An example of this could be a zoning change. This could change the use of a property ie; a side-by-side duplex with an RF2 zoning – change zoning to an RF4 and the property can now occupy four suites instead of two. The revenue will increase and therefore the value will increase. Decrease expenses – as with any business a prudent investor will look at ways to lower costs and thereby increase revenues. In Real Estate there are many ways to decrease expenses. Examples are; reduce energy costs – if the current tenants do not pay utilities they are usually not too concerned with conserving energy. Make utilities the tenant’s responsibility even if you have to reduce the rent a little. If not, install energy saving devices ie; low flow plumbing devices, sensor lights, or fluorescent lighting. Reducing maintenance costs are important as well. You may be able to do some repairs, or a handy man can be hired to do things that do not require trades people. Property management is another area where costs can be reduced – do you really need a professional manager. If you are out of town from your property or if you absolutely cannot deal with tenants then definitely. Increase revenue – Is the current rent reasonable? Can it be raised? An investor needs to be careful not to get greedy. You would not want to risk losing a good tenant. If the rent is well below market, then the tenant can expect an increase – if they move they will be paying the higher amount anyway. There may be other sources of revenue- ie; can another suite be developed in the basement? Can the garage be rented separately? Could coin op laundry be installed (only for multi tenant properties – 2 or more), or if it is installed, can the price increase? ie: $1.00 to $1.25 per machine.

 

       Real Estate has alwas been a good investment. In fact more Millionares became that way through Real Estate than any other investment. Keep in mind that investing in Real Estate is not without risk. Therefore it is essential to deal with someone with experience in this market.

 

 

 

               

 

 

 

 

 

 

    

 

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