Cash Flow — Or Else!
I was flipping through the radio stations while driving yesterday and landed on a hip hop station that was playing a song called “Cash Flow”. My first thought was “Cool, a song about real estate investing!” Upon further review the song was NOT about real estate investing. After listening to it for a few minutes it became clear to me the song was actually about drug dealing. The hook to the song made me think that this hypothetical drug dealer and the investment real estate owner actually have a few things in common.
What do you do if you don’t get paid on time? Well, let’s see the approach this “drug dealer” takes by listening to the lyrics of the hook.
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I’ll tell ya one thang dont play about mine
i be bangin on your front door wit da nine
ima come see ya (see ya)
ima come see ya (see ya)
i need all my dough not a dolla short
and if u dont have it then u gotta go
ima come see ya(see ya) hey hey we put our hands
in da sky let em know that we bout that
cash flow..i need it on time im
talkin bank roll my money my money my money
cash flow…i need it
on time im talkin bank roll my money my money my money…
As a law abiding citizen you shouldn’t be “bangin on your front door wit da nine” (nine = 9mm gun reference), at least I hope not. So how can you, the investment property owner , ensure that you receive your “cash flow”, “bank roll”, “rent check” or whatever you want to call it on time?
The best way is to avoid being in this situation in the first place is by properly screening your potential tenants. They should know from the get-go that you will be charging late fees if they don’t pay on time, they should also know that you will start the eviction process as soon as the lease and local ordinances allow it. As a last resort….you can always flash your “nine”.
All Real Estate is Local – Truth or Myth
Between basketball games at the gym I got to talking to a local agent today.He asked me what I thought was going to happen with local real estate values and I asked his opinion also. He then went on to play the “All Real Estate is Local” card while trying to justify his point. While I do agree most trends that affect real estate values are on a local level, he blatantly disregards (like most people) the national trends that affect real estate values.
There are multiple national trends that affect real estate, but I’m only going to touch upon two for this post; inflation and the psychology of the masses.
Real estate cycles are partially shaped by these national trends and they can directly influence if your next real estate investment is successful or an opportunity cost. Don’t get me wrong, you can go against the grain and invest successfully when these trends are not favorable, but great care must be taken.
More often than not inflation occurs on a national level and if you are a real estate investor, most often inflation is your friend. If prices of building material (lumber, steel and other raw materials) go up, then the cost to build a home or building will rise also. This obviously helps your investment to hold its value or more likely appreciate.In addition to appreciation, during times of inflation we can usually raise rents.
You might be thinking “so far so good”, but one of the key measurements most inflation loving investors forget is wage inflation. If wages aren’t inflating accordingly you have a bad situation on your hands, and that my friends is part of the reason most real estate markets aren’t finished correcting at the time of this writing.Their values simply aren’t inline with local wages and historical price to rent ratios.
The second trend I want to talk about today is the psychology of the masses. There are many reasons our country recently experienced probably the greatest national real estate boom in our history, but one of them was the phychology of the masses. From the year 2000 to 2005, no matter where you went people were talking about real estate. Everybody thought they were Donald Trump and money was pouring into real estate as if it was impossible for values to go down. Fast forward to today and we obviously know how that story turned out. Try talking about real estate today and most people treat you as if you have the black plague. The psychology has shifted. The proverbial pendulum swung too far in favor of real estate during those heady times and I believe it will swing too far the other way (at least in some markets) as time goes on (some markets will “over-correct”).
In summary, don’t believe the hype, while there are many trends that affect real estate on a local level, remember there are national trends that affect values too.
P.S. If you are reading this John, I will see you on the court on Monday, be prepared to be schooled again (just kidding).
Investment Real Estate – A Great Tax Shelter
I’ve found that most people really don’t understand that tax sheltering benefits of real estate investments.Your investment property can actually shelter its own income and sometimes income from other investments.>How can that be?
When it comes time to do your taxes, you have to figure how much rental income you have received and how much tax deductible operating expenses you have paid out (examples are insurance and repairs).You are left with what is known as your Net Operating Income (NOI) on which you are expected to pay taxes.One of the great things about being a real estate investor is that Uncle Sam has written the tax codes in your favor, he allows multiple deductions on your investment, so you can save money; he does that because he wants to spur on the economy.
One of these deductions is for mortgage interest.Mortgage interest on your investment property is considered an operating expense and the IRS allows you to deduct it.
Another deduction is cost recovery (official name), but is widely known by real estate investors as depreciation.Most people associate the term depreciation with decling property values, but in this case the term is associated with the tax code.Given enough time you can probably bet your real estate investment will increase in value, but you can also bet that it is in fact “wearing out”, the IRS allows you to take a deduction for this presumed decline in value.(This concept combined with a 1031 exchange is a very powerful wealth building technique)
The deprecation deduction is the most exciting part of the tax code.Out of all the deductions involved in your investment this is the only one that doesn’t require you to have written a check thus it does not affect your cash flow ( it is not an operating expense).This powerful deduction can shield most, if not all of your investment’s year to year income from being taxed.Sometimes this deduction can be so large it can cover all of your investment’s income and then in turn provide tax shelter for other real estate investments as well.(We are seeing this with our GO Zone investors)
Here is a simple formula to help you figure this out.
Rental Income less Operating Expenses = Net Operating Income
then
Net Operating Income less Mortgage Interest less Depreciation = Taxable Income
Let’s look at example of how a real estate investor can realize the tax sheltering benefits of real estate investing.
Let’s say you invested in a fourplex that had a rental income of $128,000 and operating expenses of $46,000
Rental Income = $128,000 less Operating Expenses of $46,000 = Net Operating Income of $82,000
Your mortgage intrest for the year was $64,000 and your deprecation deduction was $16,000.
Net Operating Income $82,000 less Mortgage Interest of $64,000 less Depreciation of $16,000 = $2,000 in Taxable Income
Wow! Only $2,000 in taxable income! As you can see, other investment vehicles just can’t compare with the power of properly chosen real estate investments.
Real Estate Investments In Emerging Markets Can Make You Happy
Does the investment real estate landscape in your local area look sad while other markets are on the up swing?Is your market overpriced?Does it take 25% -30% to break even or cash flow?Chances are your market was once considered an emerging market, but it has now peaked and probably isn’t a great place to invest for the time being.We work with many investors that have this problem.
When it comes to investing in real estate, many newbie investors prefer to play it safe by sticking to markets that they are familiar with. Many of the so called real estate gurus that charge for their “real estate course” say only invest in your backyard.If you are trying to do a fix and flip then you should stick to your area, but if your investing strategy is like mine you might want to consider investing in other emerging markets.
For a real estate market to be considered “emerging” it must have certain trends.>There are four major trends that we like to identify before placing our investors in a new market.
-Job Growth
- In and Out Migration
- Path of Progress
- New Construction
These four trends need to be thoroughly researched before investing in your new income property.
While it sounds very simple, there is a lot of a complex research that goes into identifying an emerging market. Our company takes the time to find the markets and do the research.Call us for for a free consultation.
Real Estate Investing: The Personal and Financial Benefits
Despite the troubling headlines in the financial pages lately, today’s real estate market can be a very hospitable one for investors. High rates of foreclosures and homeowners selling under financial duress have led to rising home inventories. Combined with the recent decline in home prices in many areas, these factors have helped to create an environment of great profit potential for the savvy real estate investor.
A traditional form of real estate investment is to purchase a home and hold it until the value rises, then sell it for a profit. These days, with so many bargains homes on the market, the patient investor has the potential to realize a much larger profit margin should the property bought in today’s struggling economic climate be held until values rise to a more typical level (assuming the market you buy in has “over-corrected”). People always need a place to live no matter how the markets flow, and properties held in this manner can bring income as rentals until the time is right for selling.
Among the most popular routes to profit in real estate investment in recent years is home “flipping”, where investors buy a home, rehab it, and sell it for a profit. While this may be a bit more difficult in the current real estate market, an investor can realize a substantial profit margin with the many low cost homes available on the market today. While homes may move more slowly than at the height of the housing boom, again, housing is a commodity that is always needed, so patience can bring profit.
Another one of the many benefits of real estate investment lies in the tax advantages that can come with such ventures. Deductions for depreciation of your investment property can be quite lucrative. Since the IRS requires that investment properties be devalued on paper by a standard formula, depreciation can also reduce the amount of capital gains tax you will be obligated to pay when the property is resold at a profit.
There are also tax benefits for investors who are eligible to be designated as real estate professionals. To qualify for these tax advantages, one must spend at least 750 hours managing real estate investments per year, or more than half of total annual working hours. If you meet these requirements, your real estate investing venture can become eligible to claim a long list of business related income tax deductions.
Aside from profit and tax advantages, real estate investing offers more freedom than the typical nine to five job. Residual income from rental properties can offer much in the way of financial security and quality of life by allowing one to work fewer hours for as much income or even more than that steady office job offers.
As with any form of self-employment, hard work and self discipline are required for success. However, those willing to spend some time educating themselves in the basics of real estate investing can find a great deal of satisfaction in controlling their own destiny while enjoying the many benefits of investing in real estate.