BOULDER – It could be called playing Monopoly in real life! How many things can you do that create wealth while you sleep? Real estate is exciting because every night when you go to bed, you have rental income coming in, values increasing over time, loan balances declining with every monthly payment, and possible tax benefits. It’s fun to watch the loan balances decline and your equity build each month.
Rental income coming in
As long as you have properties with good features, in good locations, leased with deposits, and tenants who are screened, you can be fairly comfortable that the rent will continue to come in every month. Starting out, if you are highly leveraged, there may not be much immediate cash flow. However, part of the plan is to get debt paid down and then rents will go up over time.
Values increase over time and real estate cycles
Looking at the long-term performance of the appreciation of real estate values in the U.S., it has been good over time. The very rapid appreciation of the 2000s was certainly not sustainable, and in 2007 to 2012 many areas of the country suffered a hard crash. In my 40-year career, I have seen several cycles. Real estate will cycle up again – and it will cycle down again. The goal is to learn to create a real estate portfolio that can withstand the inevitable ups and downs of any real estate market. Today there is a website at fhfa.gov where you can study the rise and fall of hundreds of real estate markets across the country. In about 2008, people were asking today if real estate would ever recover. There were high levels of excess inventory. In some areas of the country took a while. Now
in most markets there is an inventory shortage.
Many factors will fuel the next cycle:
1. Population continues to increase from births.
2. Population increases in some areas from migration and/or immigration.
3. Lack of new construction.
4. Pent-up demand of households living in parents’ basements, foreclosed and short sale owners that will once again want to be a homeowner.
5. New jobs as the economy improves.
6. Credit standards relaxing as the economy improves.
7. Low interest rates make it easier for buyers to buy.
Loan balances decline with every monthly payment
This is one of the most exciting parts of owning investment real estate. Each month you receive rent from a tenant that makes your mortgage payment. Each month the loan balance goes down. Early on in a 30-year mortgage, the principal reduction is relatively small. But as each month goes by, the principal reduction gets bigger and bigger. As loans get older, it’s fun to calculate how much your equity increases in the form of debt reduction every day.
Possible tax benefits
Prior to 1986, an investor could buy enough real estate to eliminate a tax bill. Double declining depreciation could melt away a tax bill. After 1986, real estate was pretty much forced to pay for itself rather than be purchased solely for the tax benefits. Now the depreciation benefit is still a factor, but it phases out as income rises. Each investor needs to consult their own tax expert to determine how owning investment real estate will affect them. There are increased tax benefits for those that qualify as a “real estate professional.”
“Real Estate Professional” tax status
High income tax payers are typically not able to use all of their passive losses from real estate.
For those of you who are real estate professionals, you may qualify for a special tax status that allows you to take full advantage of losses from real estate, which otherwise might be limited. If you are a full time real estate broker and work at least 750 hours in that capacity, it is likely you will meet the requirement. Meet with your tax professional to determine if you qualify and how it might affect you.
Creating your wealth building plan
Let’s get to work on a plan so that you, too, can earn money while you sleep. It can be a simple plan, such as buy one house per year for ten years. When I got started in real estate, it was assumed that real estate would always go up in value. After the early 2000s, we know that may not always be true.
But let’s take a look at an idea that works when the market appreciates over a 10-year period of time.
1. Buy one house a year for 10 years.
2. At the end of year 10, pull cash out by refinancing the house bought in year one, to the extent the rent pays for the mortgage. The cash pulled out is tax-free because pulling cash out from a refinance is not taxable.
3. At the end of year 11, pull cash out by refinancing the house bought in year two.
4. Repeat the process until year 20 and start over. Works great as long as values rise, rents rise, and financing is available when you need it.
1. Set a goal.
2. Desired income goal derived from investment rental houses $_____________.
3. To obtain that income if each house has a net rental income of $___________, the number of houses I must own free and clear is _______.
4. The houses will be free and clear by the year __________.
Goals are set, now what?
You need a down payment! Where to get it?
1. Savings. If you don’t have any, start skipping the morning latte, iron your own shirts, wash your own car, sell the new car, and get a free and clear used one! Start building your savings.
2. Sell stock, mutual funds, any other financial investments. If you don’t have any, go back to step one.
3. Pull money from your retirement account or purchase in your retirement account. If you don’t have one, go back to step one.
4. Refinance personal residence or other properties to pull cash out. If you don’t have one, go back to step one.
5. Get a second job with all earnings going into your real estate investment fund.
You get the idea – if you make a conscious effort, you can skip a few luxuries and soon you’ll have a down payment to get started owning real estate and building your financial security.
The preceding article is a summary from the book, “Realtor for Life”, written by Duane Duggan.
By Duane Duggan, RE/MAX of Boulder. Duane Duggan has been a Realtor for RE/MAX of Boulder in Colorado since 1982 and has facilitated over 2,500 transactions over his career, the vast majority from repeat and referred clients. He has been awarded two of the highest honors bestowed by RE/MAX International: the Lifetime Achievement Award and the Circle of Legends Award. Living the life of a Realtor and being immersed in real estate led to the inception of his book, Realtor for Life. For questions, e-mail Duane at [email protected], call 303.441.5611 or visit boulderco.com.