With the current volatile state of the stock market, many investors are looking to other avenues that may prove more secure. One that has stood the test of time is real estate. While it does not have the same potential for volatility and instant gratification (or regret) and adrenaline rush of Wall Street, it is an investment opportunity that can lead to great profit in the long run with the right guidance and strategy.
Real estate has many built-in tax advantages you can leverage, particularly with a long-term outlook and the advice of a good CPA and broker. Advanced tax strategies such as 1031-exchanges can further compound the long-term growth potential of investments in real estate.
Before we get into the tax benefits, let’s first look at the overall benefits of real estate. There are many ways you can make money, my favorite breakdown of these ways uses the acronym I.D.E.A.L., which represents five principles of wealth building, to illustrate why commercial real estate investing may be great for your passive income.
I = Income:
This is your monthly cash flow, mostly from rent, minus your expenses. Most of the time, these expenses are either in the form of a loan or property upkeep. In the long run you can easily see usually see levered returns of 10-15% on your properties.
D = Depreciation:
The IRS allows tax deductions based on depreciation. These deductions can’t all be done at once as they have a certain time frame assigned to different types of investments regarding their depreciation. Every year you can claim depreciation as a loss on your taxes, even if you didn’t really lose anything. In the case of residential real estate, this time frame is usually 27.5 years while commercial real estate depreciates at 39 years, so there’s a pretty good incentive to hold on to your property for a while. Check out this example illustrating the tax benefits of depreciation!
E = Equity:
Principal paydown is a quiet wealth-builder. Buying income property effectively allows the tenant to pay your mortgage for you, leave some cashflow leftover, and in the long run amasses a good equity position in the asset. With each passing payment, your equity grows, almost like a forced savings account- except with tax benefits and compounding favorabilities.
A = Appreciation:
Appreciation can be one of the most important aspects to consider when purchasing an investment property. Most share the opinion that land will almost always appreciate, as it cannot be manufactured, there is a limited supply, and demand is steadily on the rise as populations grow. Obviously this assumes you purchased at the right price. Unless something happens that causes a drop in demand or the land is rendered unusable, the property value should increase steadily over time- however, the potential for exponential increase exists when you invest in the right location at the right time. It’s this potential for non-linear upside that makes appreciation such a valuable piece of the investment puzzle. You can also force a property’s appreciation higher by improving the property; this may include a remodel or expanding on the building you already have, repositinioning the tenant base, etc.
L = Leverage:
Leverage is the name of the game when looking to purchase new properties. Knowing when to take on “good debt” is key to a good investment strategy in real estate. Just be aware that just as leveraging can increase your gains, it has the potential to do the same to your losses.
When applying these ideas to your investments, remember that most properties will not meet every principle, and you may have to sacrifice one principle in favor of another. If this is done wisely though, real estate can be one of the best investment choices you ever make.