4 Ways Owning a Rental Property Will Likely Make You Money
Although it's safe to say that real estate in general (or at least in time) is likely to prove a good investment due to some accumulation of wealth through appreciation, it should be understood that there is a vast difference in the financial gains one could receive from real estate purchased as a personal residence compared to income properties acquired through real estate investing.
The reason for this is fairly straightforward: the benefits of home ownership are not measured in the same financial terms as properties acquired as a real estate investment.
Home buyers, for instance, are purchasing a personal residence typically to care for the needs of their family. Therefore, the benefits they seek generally surround amenities like the property's size and floor plan, overall neighborhood conditions, school district, proximity to shopping, and so on. So the fact that money might be made by property appreciation and a minimal tax write off for interest expense is more a secondary benefit than a primary one.
Real estate investors, on the other hand, never buy rental income property based upon these things (other than how they might influence rents and occupancy). At the end of the day, real estate investing is all about the numbers.
Fair enough. So let's talk numbers.
The benefit of real estate investing boils down to the following four ways investors typically plan to make money on their real estate investment.
1. Cash flow
The primary purpose of those who purchase rental income-producing property is to rent out space in their asset in order to collect rental income. And cash flow is generated after the property's operating expenses and debt service (i.e., mortgage payment) are deducted from that rental income. Thus, when more cash comes in than goes out, the result is a "positive cash flow" that becomes periodically available to the investor on a regular basis.
2. Tax Shelter
One of the primary benefits of owning rental income property is being able to legally reduce your annual or ultimate Federal income taxes with the following four tax deductions:
- Acquisition costs - Most costs incurred at the time of purchase are deductible in the year of purchase.
- Property expenses - All expenses incurred in the operation of the property are deductible.
- Mortgage interest - The interest paid on the mortgage is deductible.
- Depreciation - The IRS also assumes that your buildings are wearing out and becoming less valuable over time and therefore allows you take a deduction for that presumed decline in what the tax code calls cost recovery (i.e., depreciation).
Of course there are nuances and exceptions in all tax matters that every investor should always discuss with a tax expert. But you get the idea.
3. Loan Amortization
Loan amortization signifies a periodic reduction of the loan over time. In other words, with a fully-amortized loan (i.e., not interest-only), each payment made reduces some amount of principal. As stated, home buyers enjoy loan amortization, too. But here's the difference: with a rental income property, the tenants are virtually paying down the debt—and therefore helping the investor to buy the property—each time they pay their rent.
Appreciation is also not exclusive to rental income property because any real estate sold for more than its original purchase price would benefit from appreciation, whether it be a personal residence or office complex. With investment real estate, however, the owner doesn't necessarily have to leave appreciation to chance the way a typical home owner would. The truth about real estate investing is that investors buy the income stream of a rental property. And as a result, the more income stream a landlord can generate (perhaps by lowering vacancies or reducing wasteful expenditures) the more they can expect their property to be worth; and the sooner they can impose these changes, the sooner their rental property is likely to appreciate.
Rule of Thumb
Real estate investing is all about the numbers; it's business. So avoid the same emotional feelings that may lead you to purchase a home for your family, and approach it logically; carefully run all the numbers before making any real estate investment decision.
So You Know
ProAPOD provides two real estate investing software solutions that make it easy for you to quickly run the numbers on any-size rental income property.
Here's to your investing success.