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Lesson 2:

Back for more?  OK.  You’ve figured out that if you put your $20 Grand in stocks or funds and it makes 10% a year after 5 years you’ve made about $12,000  plus the original $20,000 and you now have about $32,000.  If you made 7% a year you made about $8,000 after 5 years and have $28,000 and so on.  If you think you are going to double or triple your money every year or few months in my opinion it is highly unlikely.  I would say if you averaged 14 or 15% you’re probably doing very well.  Two notes. 1) This is totally passive.  You go to the ballgame, you play golf, you just look at your money grow (hopefully).   2) You have little or no control over it.  You can get in, you can get out, the market determines the prices and value.

 

Enter Real Estate.  How do I figure it?  First you need to know the areas and markets’ Rental Rates and Purchase Prices.  You need a yellow pad, a #2 pencil and sharpener, a good calculator and maybe learn how to use a spreadsheet.  Now the simple math. They figure commercial and residential real estate values differently.  Some methods are more complicated than others.  Basically you need to calculate the Monthly Rent X 12 Months, and subtract all projected expenses (taxes, insurance, annual repairs, maintenance, property management (5-10% of rent), possible vacancy (5%), and anything else that comes up,   from the total annual rent.  NOTICE.  This is your net income BEFORE DEBT Service (Loan Payments).

 

Now.  If you Paid $100,000 for a House.  Put up a $20,000 Down Payment (this assumes the house needs NO REPAIRS OR FIX-UP) and after expenses you have $10,000, that is considered to be a 10% Return on the investment. (If you paid $100,000 cash and had $10,000 at the end of the year, you made 10% on your money.)   Oops.  You have an $80,000 mortgage to pay out of your $10,000 “income”.  Roughly, an $80,000 Mortgage at 7% is probably going to be $6 or $7,000 depending upon terms.  SO, now minus expenses you have about $2,000 left over.  You made about 10% on your $20 grand which is what you can do in the stock market and sit on your behind while you do it.  So why go through the trouble?

 

Glad you asked.  First, Tax Write Offs.  This is the magic whereby the Internal Revenue Service (USA) let’s you deduct expenses and depreciation from investment property.  SO you may pay less tax out of your pay check (assuming you or a spouse works) as a result of that.  

 

Second,  and this is really big,  you have control over your “Market”.  If you do your homework (and you had better), you can look until you find a good deal on a property.  This determines your price vs. rental income and down payment, thus, potentially altering your income and % of return on the investment. 

 

NOW the really good part. Appreciation. What we like to call “Upside”.  If you buy at a good price (and it isn’t a piece of junk that needs to be rebuilt), in 5 years you can make your 10% a year, get the Tax Write Offs and have an asset that has gone up (How Much?- 25%? More? Depends upon your market, depends if you got a really good deal.  BUT.  In 5 Years, you could potentially Make 10% annually on Your $20 Grand ($12,000), Have another $12,000 in Tax Write Offs, Pay down some of the mortgage (that’s what tenants do) and have a $25,000 appreciation in the property.  So 12+12+25= $49,000 potential profit in 5 years on a $20,000 investment.  Admittedly not without it’s drawbacks but there aren’t any free lunches.

 

Next.  Writeoff the depreciated value, equity and Capital Gaines Taxes.  Or How about a 1031 exchange?

Written by Thomas R Fazio: Onwer of Trolley Realty, Denver Colorado