Comparatively, real estate is an incredibly versatile asset that provides four ways to build wealth. Below, we dive into all four plus a bonus method!
The increase in the value of your home is known as appreciation. Home owners love it and future home owners fear it! In 2021, home values in the U.S. appreciated at roughly 16%. To put this in historical perspective, homes have appreciated at a rate of 3 to 4% annually so 2021 was really an incredible year for home owners and investors. For a detailed explanation of why home values have increased so much recently check out my blog on here.
Deby Pay Down
Every month, when making your mortgage payment a portion of it goes to pay down the principal on your loan which is essentially forced savings. Over time, this is an incredibly powerful wealth building tool especially when combined with appreciation.
As a home owner, you will get to deduct the interest paid on the mortgage for your primary residence against your taxable income. For example, if you make $70,000 in taxable income per year from your job but you pay $5000 in mortgage interest, the government will allow you to reduce the amount of income they tax you on by $5,000, making your new taxable income $65,000. If you pay say a 22% tax rate this would be a savings of about $1100 dollars on your taxes.
If you were to buy a piece of residential real estate as an investment to rent out, you would get to take advantage of this same interest tax deduction on the income from the property. However, investors get an additional tax benefit known as depreciation. Depreciation allows you to write of the value of the improvements (buildings, not the land) over the course of 27.5 years. An example of this would go as follows:
You buy a $200,000 town house and the building is valued at $180,000 and the land it is on is valued at $20,000. $180,000 divided by 27.5 equals roughly $6545, meaning you would be allowed to deduct $6545 from your taxable rental income.
Disclaimer: I am not an accountant. Consult your CPA regarding your specific situation.
Last but certainly not least is cash flow and this is what inspires most investors to get in the game. Before you buy real estate as an investment you need to come up with an accurate projection of your cash flow or you risk placing yourself in an unsustainable situation. To project your cash flow, determine what you believe you can rent out the property for. Real estate agents, property managers or online subscriptions like Rentometer are great resources for determining what a property will rent for. Feel free to contact me and I can help you with your projections. Next, you estimate your expenses. These may include but are not limited to vacancy, maintenance, capital expenditures, taxes, insurance, principal, interest, management fees, utilities, local licensing or inspection fees. Whatever you have left over once you subtract your expenses from the projected income will give you your cash flow.
Individually, each of these tools for building wealth through real estate is not that powerful. However, when they are combined and working in harmony with each other the results can be impressive. Because of the reasons listed above I have always subscribed to the idea that you should but real estate and wait, not wait to buy real estate. Give me a call today and let’s buy some real estate.
There is a 5th tool you can use to build wealth when you own real estate: Leverage. Debt. Whatever you want to call it. You can take out loans against real estate that you already own and use those loans to buy more real estate so that you can take advantage of the appreciation, tax advantages, debt pay down and cash flow on an even larger scale!