90% of all millionaires become so through owning real estate. Many famous figures ranging from Andrew Carnegie to Jennifer Aniston have made huge amounts of money by deciding to invest in real estate.
“Real estate is the best investment you can make” is an adage that still rings true today. Unlike the stock market, where many factors are out of your control, your investment can’t disappear overnight.
You can also build your wealth with excellent return rates. Shark Tank’s Barbara Corcoran started her joined to financial prosperity with a $1,000 loan, which she used as a down payment for a tiny L-shaped studio in the 1970s. A few years later, the studio doubled in value and gave her enough cash to put 50% down on a one-bedroom apartment, then a two-bedroom, a three-bedroom, and eventually a 10-room penthouse on Fifth Avenue in New York City. By the time she sold her company, The Corcoran Group, in 2001, she net $66 million from the deal.
While Corcoran’s story is an outlier, many people have enjoyed a comfortable living off of real estate investments. Here’s why:
Real Estate is a Great Source of Income
When you invest in real estate, you have a great opportunity to generate cash flow from renters. Let’s say that all of your rental property expenses - mortgage, property taxes, HOA, etc. - comes out to $2,500 a month. If you rent it for any more than $2,500, you’re going to make a profit. Renting it for $2,800 a month will net you $300/mo or $3,600 a year, while $3,000 with net you $500, or $6,000 a year!
Even the S&P 500, which averages an annual return of 10%, won’t net you that much. In fact, if your total mortgage expenses come out to $2,500 and you’re renting for $3,000, that’s a 20% return - double that of the S&P 500.
Now imagine if you owned two homes, or three, or a small building. The money adds up pretty quickly. Just ask Barbara.
Are you like most people and don’t have that kind of cash lying around? Check out sites like Diversy Fund, where you can get involved in crowdfunding real estate with a minimum entry of $500 and no management fees.
Depreciation: It’s Actually a Good Thing
Depreciation usually carries a negative connotation with it - which makes sense. It literally means the “reduction in the value of an asset with the passage of time.” When comes to real estate, depreciation is an accounting method that allows you to deduct the value of your home.
Each year you can write off 1/27.5 of your property’s value against the income you’ve generated. The one caveat here is that this tax exemption doesn’t apply to your primary residence - only rental tax properties (however, primary home-owners are still able to deduct mortgage interest, property tax payments, and other expense from their federal taxable income if they itemize their deductions).
If you bought your home for $300,000, then you are able to write off $10,909 in depreciation.
To put this into context, if you buy a home for $500,000 and you’re spending $2,500 a month on mortgage-related expenses but are renting it out for $2,800, you’re not just making $300 a month. You’re also collecting $1,515 a month in depreciation.
However, the amount of depreciation that you write off also decreases after each year. If you’ve written off $18,182 for the first year, that will count against your $500,000 for the second year. This means that in year two your depreciation will look like: ($500,000 - $18,182) / 27.5 = $17,520. In year three: ($500,000 - $18,182 + $17,520) / 27.5 = $16,883, and so on.
You can also add value you your home through remodels. If you spent $50,000 on an upgrade, you can add that to your $500,000 value and write off $550,000/2.75 in depreciation.
As you can see, depreciation on a property can get pretty complicated. For more information, check out this post on real estate tax depreciation basics.
Appreciation: It’s Also a Good Thing
When you invest in real estate, you get the best of both world. Not only do you get to write off depreciation, but rent estate values usually increase over time. NeighborhoodScout.com’s data shows that Seattle real estate appreciated 84.92% over the last ten years.
If you bought a $500,000 home ten years ago and followed this average, it would be worth $924,600 today. This is an average annual home appreciation rate of 6.34%, which puts Seattle in the top 10% nationally for real estate appreciation.
Invest in Real Estate: Building Equity
As you pay down your mortgage, you’re also building equity.
Your mortgage payment consists of two main categories: interest percentage and principal owed. We created a table in our post about housing costs that illustrates how much this comes out to at first.
By using Bank Rate’s amortization table you can see exactly how much of your money goes toward your interest rate with the bank and how much goes to your principal balance every month throughout your entire mortgage. With each payment, you own more and more of your property. If it’s a rental property, the renters are essentially paying off your mortgage for you!
Lets math this real quick.
Let’s say you’ve bought a $500,000 with 20% down, so your mortgage is $400,000 at 2.5% interest for a 30-year fixed loan - one of AmeriSave Mortgage’s current rates. Your first payment would be a total of $1,580.48 ($747.15 principal, $833.33 interest). Each month, the principal goes up a little and the interest goes down, but each payment remains the same. After 10 years, you will have spent $87,917.13 in interest and $101,740.90 in principal payments.
IF the value of your home doesn’t increase at all, you’ve accumulated $101,740.90 in equity. However, if the housing market follows the same trend in the next 10 years that it has in the last 10 years (which is highly unlikely), and your home is now worth $924,600, you will have accumulated $626,340.90 in equity - including your $100,000 down payment.
Even if your house increases by half that much ($212,300, not $424,600), you have still accrued $414,040.90 in equity.
The final reason that you should invest in real estate is for leverage.
Leverage means that you can pay for something without coming up with the total cost of it. In real estate, you can buy a home by only paying for a part of it and then using leverage to take out a mortgage. Even though you’re only paying for a small portion of the purchase price, you are entitled to all of the benefits.
For just a down payment on a $500,000 rental property, you can depreciation off of all $500,000, not just the portion you’ve paid for. You get all of the equity build up, and all of the appreciation of the property.
In short, leverage is awesome!!!
Invest in Real Estate
Real estate investments offer you benefits that no other investments can. It’s no wonder why they’re so popular, or why so many people have used it as their key strategy to accumulate wealth. If you want to know if real estate investment is right for you, or how to get in the game, send us a message. We’d love to chat!
Anthony Greer specializes in content writing and brand messaging development for service-based businesses. www.anthony-greer.com