Category Archives: 4 Benefits of Real Estate Investing

November 18, 2007 · 5:36 pm

Real Estate Investing Returns Calculations

Calculating projected returns can be of paramount importance when deciding on whether or not to pull the trigger on any particular investment property whether it be here in Kansas City or elsewhere. After all, real estate investing is about securing a return. Without that return your money would do better to be somewhere else.

So before buying that next “income” property you need to know whether there will be any income. (That’s why I get paid the big dollars.)
Of course how you calculate that return is completely up to you. Jeff Brown recently discussed his Einsteinian theory over at BawldGuy. See the post here. And a nice little Q&A session happened in the comments section so be sure to read those, as well.
Let me just say that I prefer to know what the equity return on any investment property will be before I buy it. What is equity return? Quite simply it’s how much I am receiving in benefits divided by how much I have invested.

Remember the 4 Benefits of real estate investing?
  1. Cash flow before taxes.
  2. Principal reduction.
  3. Depreciation.
  4. Appreciation.

Let’s take the calculation of these step by step.

#1 was cash flow before taxes. Simple enough. Just take the amount the property is actually bringing in and subtract the amount the investment property is actually costing you. What’s left over is your cash flow before taxes.

#2 was principal reduction. Again, quite simple to figure out based on the loan you have taken out. If you took out an interest only loan (you’re welcome, Jeff) then you won’t have any. If you have taken out almost any other kind of loan you can just look at your amortization table and figure out how much principal reduction there should be in any given year for your rental home.

#3 is depreciation. Okay, I could do an entire post here. Or two. If you are breaking down your depreciation between land and building only then you depreciate the building over 27.5 years. Rather simple to calculate and all you have to do to figure out the number is to refer to a depreciation table as to when you put your rental property into service.

If you choose to accelerate your depreciation through cost segregation then you will need to do some more figuring. But it’s really only a few more steps. Although, that may be over simplifying things.

#4 is appreciation. Wow! Have you ever tried to predict appreciation? How did that work out for you? Listen, you can guess at what it will be and be awfully darn sure of what it was. But when figuring out if an investment property will be a good buy RIGHT NOW you are going to want to buy a rental property that will make sense based on the previous 3 benefits of real estate investing. Then appreciation is icing on the cake! And you wouldn’t buy a cake unless you knew it would have icing, right? (I know, there’s pineapple upside down cake. But let’s move on.)

Again, before buying your next Kansas City real estate investment property you need to know before you buy whether or not that was a good idea. Take the time to work through your calculations to see if the rental property will be a good buy or a drain on your current resources. After knowing you are making a good investment then you can go back to planning your retirement worth having.

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November 7, 2007 · 9:46 am

Securing A Retirement Worth Having

Securing a retirement worth having takes forethought, perseverance and planning. Exactly what a couple I’m working with right now has.

You see, they have a sweet equity position in their current principal residence. Now they could go out an buy a bigger home. One with another garage, an extra bedroom for that once a year visitor (wouldn’t a hotel room be cheaper?) or the back yard that would blow all their friends away.

Or they could take money out and go on that vacation that would make you drool. Or how about driving a car that will turn heads?

No, this couple decided to do something rather boring. They decided to get rich slowly. They decided to plan for a retirement worth having by investing in real estate. Not the kind of real estate investing that you see on HGTV. Not the kind of real estate investing that is helping to bring down the sub-prime mortgage market.

The boring kind of real estate investing. The kind where you buy a house or duplex and you rent it out. Then reap the Four Benefits of investing in real estate. What were the Four Benefits, again?

  1. Cash Flow Before Taxes
  2. Principal Reduction
  3. Depreciation
  4. Appreciation

Want to know how these numbers work together in concert? Just email me and I’ll send you a sample analysis. You can judge for yourself.

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September 19, 2007 · 8:17 am

Net Operating Income aka NOI

Yesterday I posted a short article titled Do You Like To Play Russian Roulette? And I joked that you don’t want to do a financial analysis of your potential investment properties if you like to live life on the edge.

Of course, I was joking. (Though some didn’t seem to think it was funny based on an email I received.) You do need to do a financial analysis of EVERY property you are considering for your investment portfolio. Every one of them.

Net Operating Income can be the key number when working your financial analysis for these rental houses. How do you determine Net Operating Income (NOI)?

Annual Rent
–
Vacancies
=
Gross Operating Income
–
Expenses
=
Net Operating Income

Pretty simple formula, huh? Wait. How do you know what numbers to plug in? It’s critical you know the actual rent values of that rental property AND that neighborhood. It’s critical you can determine the vacancy rate. It’s critical that you know each and every expense.

What expenses should be included? Anything that costs you money to run that home. Insurance, real estate taxes, repairs, HOA dues, management, utilities, advertising, supplies, mileage, signs, miscellaneous. Get the picture?

Once you have all of those numbers (ever heard of a Schedule E?) then you can get down to putting pencil to paper.

Have fun.

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August 16, 2007 · 9:15 am

Depreciation: #3 Benefit When Investing In Kansas City Real Estate

Did you know that the IRS allows you to depreciate your real estate holdings? Of course you did.

Quick. How long does it take?

Right. Twenty-seven and a half years (well, that’s not exactly accurate but we’re talking about our government setting this up, right?).

Also, wrong. Did you know you could break out your depreciation? Sure, the building has to be depreciated over 27.5 years. But what about your personal property within the house? i.e. carpeting, lighting fixtures, appliances, etc. Five (5) years! At a much higher percentage.

And land improvements can be depreciated over the course of only 15 years. What are land improvements? Landscaping, sidewalks, stairs, driveways, etc.

All this is called Cost Segregation. And it’s too complex for me to explain all the benefits of accelerating your depreciation here. Feel free to do some research on the web or ask your tax planner about it. But sadly, it’s over the heads or beyond the knowledge of many tax “specialists” as well.

Make sure that if you choose to take advantage of Cost Segregation for your rental income properties that you have a tax preparer that understands what Cost Segregation is!

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August 15, 2007 · 8:10 am

Principal Reduction: #2 Benefit When Investing In Kansas City Real Estate

This week I have been reviewing the 4 Benefits of real estate investing. And today I want to re-tackle the #2 benefit of principal reduction. Actually, I’ve done this before and I’m not really sure that I could do any better. So click the “before” link and read. Also be sure to read the comments because a great alternative is discussed.

Personally, I love the fact that each month I collect rent a portion of that rent is going towards the reduction of my loan balance. I love that my tenants are buying me a house! But Jeff Brown makes a great argument about using interest only or negative am loans to accomplish even greater growth.

Jeff has been doing what I do for about 30 years longer than me. So do you think I’m going to say he’s silly? That’s 30 years of real world experience. I listen when he talks. But on this subject, I still take it case by case.

In a faster growing market I think the advice to go interest only makes sense all the time. Here in Kansas City when investing in real estate I want to weigh the options of what the rent will bring, down payment involved and how high I expect the growth to be over the next 5 years. (A forecast, at best.)

Kansas City real estate is currently still on an upswing, growth wise. Though much slower than several years ago. Heavy inventories and rising foreclosures have dampened our normal 5%-7% growth to around 1%-3% in a lot of areas. Still not bad when considering the coasts.

So be sure to look at alternative mortgages when buying your next Kansas City real estate investment property. But get some advice and do some calculations before deciding to go with either. Sharpen some pencils and go to work. Make an educated decision.

Your thoughts, Jeff?

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August 14, 2007 · 9:30 am

Cash Flow Before Taxes: #1 Benefit When Investing In Kansas City Real Estate

I have spoken before about the 4 Benefits of real estate investing. And in many parts of the country the first benefit, Cash Flow Before Taxes, is very hard to obtain. But here in the Greater Kansas City area it’s pretty tough not to do…at least if you come in with some capital.

I’ve posted the formula for determining cash flow before taxes before here. If the term in new to you I would really encourage you to go back and study it.

The key to remember is that just because your rent will cover your PITI (Principal, Interest, Taxes and Insurance) that doesn’t mean your new rental property is cash flowing. Heck no. What about property management expenses, if any? How about utility costs when there is a vacancy? (Are you gonna let those water pipes freeze in January when the house is empty?)

Other costs to consider;
  • Vacancy rates.
  • Maintenance fund for general repairs.
  • Lawn care fund even if tenant is mowing.
  • Sinking fund for that roof that looks like it’s almost done, or the furnace, or the water heater, or the foundation, etc.
  • Administrative costs like LLC expenses, travel and tax preparation.

That’s not an all encompassing list. But unless you want your personal account to continue to kick in for your rental property until you sell it 5-7 years from now you will probably want your rental property to pay for itself, right?

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August 13, 2007 · 9:41 pm

The Four Benefits Of Real Estate Investing…Again

I was talking today with someone who had found me on “the web.” As I spoke to him about the four benefits of real estate investing I realized that it had been a while since I had done a post about them.

Now, if you already know them, feel free to skip this post. Or take a refresher. Since about 60% of my visitors each day are first time visitors I’m going to assume many of you have not stopped by before.

Here are the 4 Benefits of Real Estate Investing…as I see them. (Quick, if you’ve been here before see if you can name them before moving on!)

  1. Cash Flow Before Taxes
  2. Principal Reduction
  3. Depreciation
  4. Appreciation

(How many did you get? If you got all four, congratulations! I’ll give you a gold star if you’ll send me a self addressed stamped envelop.)

Yes, there are other peripheral benefits. Leverage. Everyone knows about housing. Easy loan qualification. But the financial benefits can be boiled down to these four.

Do you know how to calculate them? Better learn. What is appreciation in your area? Historically? How will you be utilizing depreciation?

All those are good questions to help you successfully calculate the returns each and every rental property is bringing home for you.

Here’s a tip for you seasoned investors. If the last time you calculated the four benefits was when you were considering purchase, perhaps you need to do it on a yearly basis. Remember, as time goes by depreciation schedules begin to take a dive. Could that equity in the one property be better served in two? Just a question. The numbers will probably give you the answer.

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