If you read my article about why everyone should have real estate in their wealth portfolio, you know that I am passionate about the power of real estate and its use as a wealth builder for anyone. Unlike other assets, real estate has an unusual wealth building potential, in that wealth is built in four different ways.
To start, the first two wealth builders are not unique to real estate, but the effects on your cash returns are greater than other asset classes due to the power of leverage, a wonderful characteristic of real estate.
Cash Flow
Cash flow is the prerequisite in most real estate investments. What this means is that you are being paid to hold the asset. Each month, you are generating income from rent, which allows you to save that income for reinvestment if you choose, and such compounding can have astounding affects on your wealth.
Appreciation
Over time, a sound real estate investment appreciates in value. In my opinion, appreciation should be considered the icing on top of the cash-flowing cake. In other words, one should not invest only for appreciation and ensure that there is cash flow. If purchased at the proper valuation, during a reasonable holding period, perhaps 5 to 10 years, between the cash flow and appreciation, there should be sizable returns for the investor.
These next two wealth builders are unique to real estate, as oppose to stock investing or other asset class.
Debt Paydown
So, you have an appreciating property that pays you to own it; can it get any better? Wait there’s more…In addition to that, your tenants are paying down the debt on your asset for you! Now that your debt service payments are automated and paid by those who enjoy your property, your own funds from the cash flow can be used to invest in more real estate!
Tax Benefits
As if these characteristics of real estate were not enough, there is one final benefit, and that is the tax advantages of real estate. While there are many tax advantages to real estate, the two that I will talk about are depreciation and tax-free borrowing:
- Depreciation: After accounting for net income, real estate investors further deduct from that number the depreciation of their asset. This allows for real estate investors to report smaller profits to the IRS, thus lowering the tax burden. In cases where there is a net loss on a property (paper loss on your tax return), investors can use that loss to offset gains on other properties.
- Tax-Free Borrowing:The second tax advantage that excites me a great deal, and that I am currently in the process of using on one of my properties, is tax free borrowing. Referring back to the second wealth builder that i described, appreciation, investors can refinance their property, essentially converting that equity into cash for more investing or other uses. The money that is pulled out of your asset is yours and this is not considered a tax event. In the eyes of the government, it is considered borrowing and not income, which makes plenty of sense.
- Note: For more on these tax advantages, you will want to consult a CPA, who can advise you and answer any questions pertaining to your specific situation.
What other asset class pays you to own it, grows in value, allows someone else to pay the debt service and also gets tax benefits that allow you to offset profit and even take losses on your income?
