The 5 Reasons Why Real Estate is the Best Wealth-Builder for Members of the Military
May 22, 2017
Military Real Estate Investing – The 5 Reasons Why Real Estate is the Best Wealth-Builder for Members of the Military
Real Estate Investing in the United States is magic. Investors from other countries often disregard any additional resulting taxes and invest in our real estate market. It boggles their mind that our system is so profitable. If you or your parents were caught up in the 2008 crash, you are probably on edge about real estate and that is completely understandable. However, all it takes is arming yourself with knowledge of the system to be ready to capitalize on the next market crash instead of simply surviving or even drowning amidst all the hysteria.
There are FIVE specific aspects of real estate that show why it is a fantastic way to build wealth. Each aspect is reason enough to take the plunge, but when properly combined, the results cannot be overlooked.
- This term is thrown around so often, it has almost become a buzz word. The problem with buzz words is that people rarely understand their true meaning. Leverage, according to Investopedia, is "the investment strategy of using borrowed money." Here is how I like to think about it: it’s a way to invest MORE money. This money is not yours, in fact, you are paying interest on this money. However, at the end of the day, you are now putting more money into an investment than before. The best part is, the gain you make on that money is multiplied proportionally to the ratio with which you borrowed that money. For example, if you had 20 dollars and you made 5% interest on that money in a year, you will have 21 dollars. If you used those $20 to leverage (or borrow) another $80 at 3% annual rate, and you make a total of 5% from the entire $100, you will end up with about $22.60 after paying your lender. This may not seem like a lot because we are talking about a $1.00 in return vs $2.60, but in this example, the return on investment is 160% greater! Now imagine if the difference between the interest you are charged vs the interest you make is even greater... And now imagine you are working with larger sums of money. The simple truth is, if you are making more interest from a sum of money than the interest you pay for borrowing that money, you are a smart investor. For the sake of making my point, I am over-simplifying this example and not taking into account inflation and other various factors.
- Depreciation and Appreciation
- This is where things really start getting magical.These are two very separate topics, but I like talking about them together. The economic trend, according to the U.S. Census is that homes are appreciating at an average of 5.4%. Although, some experts believe it is closer to 3.2%, that is not the point. All inflation and other factors aside, that is a halfway decent return on investment already. Especially when you consider all the bonds people are invested in for a mere 2% return.
- Depreciation is exactly the opposite of appreciation but only from a tax perspective. This fact is what really makes a difference. In the eyes of the Internal Revenue Service (IRS), a real estate investment is a depreciating business asset when used as a rental property. In other words, the IRS considers Real Estate to slowly lose its value. Now, this would be true if a piece of property just rotted on the side of the road with no maintenance or general care. Let us assume that a certain real estate investment will receive the required maintenance and care. We know that it will not lose its value in the long run. In fact, if you are smart about how you buy, its value might appreciate several times more than the nation’s average.
- But STILL, the IRS considers it to be losing its value! Why is this important? Because the value that it loses can be deducted from your taxable income. Boom! Depending on the kind of investment property you own, its value will diminish down to zero over 27.5 or 39 years. So, if you paid $275,000 for your rental property, you could potentially deduct $10,000 of income every year. If you combine that deduction with the mortgage interest that you will also be deducting, your taxable income from that property will most likely be ZERO. If this concept is still not making a big enough impact on you, just understand this: there is a way to invest in real estate and not pay taxes. This is NOT a loophole. In fact, the United States Government wants you to do exactly what I just described. But more on taxes later.
- This is the next big piece of this magical puzzle. Appreciation is something I try not to consider when analyzing a real estate investment. Instead, I focus on cashflow. The calculation is very simple: monthly income (rent) – monthly expenses (loan payment / utilities / management / taxes / other) = monthly cashflow. The reason why cashflow is the most important metric is because A) I want to know that the property can at least pay for itself. This renders less investor stress and makes it a more of a passive investment... and B) The goal is to create additional streams of income. If you are not making money after all expenses are paid, then you are shooting your lifestyle in the foot. Another good metric for knowing how well you are doing is Return On Investment, or ROI. If you want to understand how well your money is working for you, just add that cashflow up annually and divide that by your down payment to get your ROI. I shoot for an ROI of over 10% cashflow return, also known as "cash on cash return."
- Tax incentives
- Specifically depreciation, interest deduction, and other business expenses. I already wrote about deducting a properties depreciation, but I only briefly mentioned deducting interest from your mortgage. In order to really gain an appreciation for how much you can deduct in interest, you need to understand the basics of a loan. Without getting into the weeds too much, just understand that a portion of your monthly loan payment, or mortgage, is interest. If you are in the first half of the life of your loan, you pay more interest than principle. For example, let's say that during some particular year your mortgage totalled $30,000. For the sake of this simple example, let's say that $20,000 of that was interest and $10,000 went towards principle. In that particular year, you can deduct $20,000 of your income. If we use the same example as primary residence (not a rental property), all of that interest can be deducted from your regular income. So if you are in the 15% tax bracket, $20,000 * 15% = $3,000. So that is $3,000 LESS income taxes coming out of your pocket ($3,000 greater return)!
- Business expenses can also be deducted. I always laugh when people get more excited about writing off an expense then if they simply had the option to save that money altogether. Everyone hates taxes. So much so, that people would rather get a discount on an expense then if that expense somehow disappeared. Here is the simple little fact that most people just forget or do not understand: writing something off as a business expense means you are STILL paying for it. The only difference is, you are now getting a 15% (or whatever your tax bracket) discount. This is because you are spending money that has not been taxed yet. And when you write it off as an expense, you are still spending that money, but you never pay the income tax.
- Net Worth Growth
- It’s fun talking about net worth. It is what wealth building is all about. When I discussed interest deductions, I mentioned that a part of your mortgage payments goes towards principle. Just to make sure we are all on the same page, when someone refers to principle in the financial world, they are talking about paying off the money you borrowed. In the context of real estate, think about it like slowly owning more and more of your property. One slice at a time, ownership of the property is slowly being transferred from the bank's hands to yours. If you own multiple rental properties with tenants paying off your loan, each and every one is increasing your net worth each and every month.
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In summary, real estate investing is magic. You can purchase a property, which is essentially a business, for only a 4th of a 5th of its cost and earn tax-free money every month. Simultaneously, you will be growing your net worth and there will be people - other than yourself - paying off YOUR loan. Additionally, you will have the added benefit of deducting all the interest, depreciation, and business expenses within your company. And then, of course, there is the absolute cream on top of potential appreciation happening. But remember, I don't plan on it when I analyze a deal.
Specifically for the military… Three words, Veteran Affairs Loan, or VA Loan for short. I feel like this is the most obvious perk of being in the military, but I am surprised at the amount of pushback and fear associated with taking out a mortgage. At the end of the day, you need to be smart. Like with any investment, do your homework. Be smart and make it happen.
And... Guess what!? We actually have a FREE course dedicated to explaining all the cool things you can do with your VA Loan and all the mistakes NOT to make... Click here to check it out!
Article was written By Markian Sich.