There are ten major ways to make money in real estate, four of which are available in ALL properties. The other six will vary from property to property. Making money in this business is limited only by one’s imagination, and the prevailing laws in your country, state or province, county or parish, and city; however, there are different schools of thought when it comes to which vehicles you should use when you try to invest for a living. for Part 2 of this post click here.
The First Four – Count on Only One
Making money in real estate can be as simple as holding on and waiting. To get the most appreciation in value, however, you should master a few skills. Here is the real secret to appreciation. Buy in an area where demand is growing faster than the supply. This is not always the easy thing to do. In theory, you just get yourself ahead of the rest of the investors. Get in the growth corridor and bingo, instant appreciation. Here are the inherent flaws in this way of thinking.
You are NOT Psychic
Are you clairvoyant? Are you one of the “founding fathers” of the area? If you are, then you are set. If not, you will never know for sure which direction everything is going to grow. Once the sprawl heads a particular direction you can certainly get on the train. But by that time prices are going to be heading up which of course means profits will be heading down.
let’s go back to the 2008 Finacial Crisis. Many people who were counting on appreciation saw values drop hard. Some values sunk WAY below what they paid. Not a major issue if you are in it for the long haul. What about those in negative amortization loans, like so many folks in California? Areas of Arizona like Phoenix became ghost towns overnight? Often, homeowners were better off walking away from the house. Foreclosure really looked like the better option. There just was not an incentive to wait around for the value to turn around.
You are making money in real estate when you gain equity with every payment you make. well, that is true provided you do not do a Negative Amortization Loan. Get the lowest interest rate you can and more of each payment will go towards the principal. If you can in any way afford to do it, pay a bit more each month to the principal; even if it is only $50 or $100 bucks. This works especially well in the very beginning of the loan. In the beginning, the amortization schedule has you paying 99% of the payment to the interest. only 1% or less goes to the principal.
An Equity Example
A 250,000 loan on a 30 year fixed at 5% costs 1342.05 per month. Over the course of those thirty years, you will pay $233,141.28 in interest. This means nearly 50% of the money you give the bank over the next 30 years will be interest. AND, you will pay almost double what you negotiated for the use of their money.
Now, add a mere $100 bucks a month to the payment. With a little discipline you can do that, just go out to dinner one less time per month with your family. You just knocked nearly 5 years off the note, and saved more than 38,000 bucks in interest. If you bumped it up to $200, you save more than 65K in interest and pay off the loan in 22.5 years instead of 30. Go get yourself a sportscar with the 65K you saved.
The federal government has decided that eventually, all things are worth nothing. Here’s what this means for you. After all the tax law changes, you still get to declare a loss for depreciation that doesn’t exist. Yet another way of Making money in real estate. If you are an investor, this can save you a lot at tax time, meaning more after-tax profit. To maximize this you need to buy a property that has its value primarily in the buildings. You can’t depreciate the value of the land.
A Few Caveats
Now, there are a few quid pro quo’s you need to know about. After twenty-seven and one-half years, you cannot depreciate the property anymore. That is the point at which the feds say that it is now worth nothing. So, the problem comes if you sell something worth nothing for $500,000 you have a very large capital gain. the IRS is going to want 15% of that gain. Don’t fret; our boys on the hill have got this one figured out too.
Just buy another property. Be sure it is for more than what you sold the half-million-dollar property for. Then fill out some paperwork. There is ALWAYS paperwork with the feds, right? Do a “1031 Exchange”. When you do, you get to start the depreciation process all over again. and if you bought the other property for say $500,001 then there in no capital gain. well, Okay, there is a capital gain on 1 dollar!
When you buy income property the right way, you also have positive cash flow. You not only have your tenants paying all the costs but also paying down the mortgage loan.
Hear this guys,
THIS IS THE WAY TO BUY PROPERTY.
THIS friend, is making money in real estate. As far as I am concerned this is the ONLY way to buy a property that you plan to hold. The other three ways to make money in this business are all what I like to call “phantom money”. In other words, it may or may not be there and a bunch of it has to do with things completely out of your control.
I would like to tell you a short story.
An investor I know got in hot water with several commercial properties a couple of years ago. This was back when the market went south; mid-2009. Some of the events that followed were due to her own stubbornness. Others were completely out of her control. in the end, she became severely behind with the building payments. She found herself with no cash flow and millions of dollars in mortgages. I could give you all the long gory details, but the short version is that she had an opportunity early on to walk away. if she had done so, no major financial harm would come to her. She argued that she would lose a million in equity. My reply was,
“if you have a million in equity, auction it. Get the money out and retire. Move to your second home in Costa Rica and walk away from all the headaches”.
Her reply was,
“Well I can’t get a million in this market…especially with an auction”.
She got very irritated with me when I told her the truth, but guys here is the truth. The “equity” you have in a property is only based on what somebody will ACTUALLY PAY for it. Today. Now.
If nobody will buy your property then it pretty much isn’t worth a penny. You can get three different appraisals from three different companies. I can guarantee they will be three different prices. I can guarantee you something else too. NONE of them will be what the property sells for, particularly when you are in a hurry to sell it.
Said another way, Cash flow will buy your groceries and put gas in your tank; Equity, Depreciation and Appreciation will not!