4 Benefits to Real Estate Investment
Real Estate holds a special place in an investment portfolio, allowing it to be customizable to one’s risk profile. In addition to the risk customization, real estate has four innate benefits that are often overlooked such as; tax advantages, active cash flow, principal pay down, and appreciation.
Tax Advantages
o There are many unique tax advantages available to those that invest in real estate. Some of the IRS rulings that exist include Internal Revenue Code (IRC) 121 which allows the taxpayer to exclude up to $250,000 ($500,000 for taxpayers who file jointly) on the sale or exchange of property that is used as principal resident for at least two (2) of the five (5) years before the sale. There is also the 1031 exchange, where one can defer their capital gains to their next investment instead of paying capital gains when selling their original investment property. Keep in mind that there needs to be debt on the next property, or one is unable to gain the tax benefits of depreciation.
Active Cash Flow
o When structured correctly, an investor will receive monthly cash flow from the rent that the tenant pays after factoring expenses (management, tax, insurance, repairs, etc.) One of the common ways to figure out one of the ranges one might receive through this would be calculating the cash-on-cash return on the investment. Cash-on-cash return is the annual return that is received in relation to the amount of mortgage paid during that same year. (Cash-on-Cash Return = Annual Pre-Tax Cash Flow / Total Cash Invested with Annual Pre-Tax-Cash Flow = (Gross Scheduled Rent + Other Income) - (Vacancy + Operating Expenses + Annual Mortgage Payments)).
Principal Pay Down
o When executed correctly, the tenants will be paying down the investor’s mortgage or debt service on the property. This effectively lowers the loan and increases the equity of the investor. If the asset is held for an extended period of time, the property may become free and clear!
Appreciation
o There are two primary types of appreciation when it comes to real estate investment; forced appreciation and market appreciation. Forced appreciation is based on the income produced by the asset that the investor has control on (through repositioning the investment or re-tenanting the asset). Market appreciation is dictated by the supply and demand of the asset.