Many would be investors have heard the stories about rich investors who are able to live off of the passive income that their rental properties generate. Now that the stock market has become so unpredictable, it can be tough to isolate the proper investments. That’s why so many investors are turning to the world of real estate.
The wealth that real estate allows an investor to build is considerable. However, there are many who forget to ask the most important questions before getting started. Why is real estate so much more effective for the wealthy? The time has come for a closer look at the most pivotal queries.
Multifamily residences provide a level of control that cannot be matched. Control is one of the most crucial factors in real estate investment, next to debt and taxes. Today’s investor benefits immensely from the leverage that multifamily properties provide. The IRS has also enacted any number of rules that are designed to benefit the investor.
Purchasing an Apartment
Let’s say that the investor has decided to purchase a building for $2 million and they have placed a $400,000 down payment on the structure. An 8 percent capitalization rate is commonly expected in these instances. This leaves the investor with a net operating income of $160,000.
After calculating the mortgage payments and the repayments to the bank for the remainder of the necessary monies, cash flow is in the $70,000 range. Thanks to the depreciation tax benefit established by the IRS, the investor does not have to pay taxes on this income. This may seem simple enough but there are other pieces to this puzzle and they are commonly used by the wealthy.
Using Taxes In a Beneficial Manner
Thanks to IRS cost segregation studies, investors stand to benefit from taxes in a number of ways. Personal property assets are identified and reclassified when it comes time for taxation to take place. This allows for the depreciation time to be shortened and this allows the investor to reap the advantages of reduced taxation obligations.
The investor enjoys the tax savings much sooner because the IRS is making sure of it. Instead of being forced to pay 35 percent, a cost segregation study can reduce these obligations to just 9 percent. This may seem too good to be true but this is just the beginning.
The Awesome Power of Debt
Amortization is closely associated with debt. This is how wealth is going to be built. When the investor takes on debt when purchasing a building, their tenants are responsible for helping them to pay it down each month by providing rent. That is what amortization is all about.
For best results, investors should never make the mistake of assuming that their property value will continue to rise. Speculation must be avoided at all costs because it leads to much riskier investing. Since multifamily residences produce a certain amount of income, the wealthy are able to exercise a greater level of control.
Controlling income means controlling value. If any source of ancillary income is added to the property, income and control are both increased. The same is true if the property’s expenses are decreased. Operating expenses are often slashed by investors for this reason.
Multifamily Value Increases
Let’s say that the $2 million apartment building from above contained 40 units. The investor may realize that the previous owner was not keeping up with the current marketplace when it comes to rent prices. Instead of maintaining the status quo, the investor can increase the rent by a mere $50 per month and add $2,000 per month to their bottom line.
Vendor costs are another way to increase value. If these costs have started to rise to a level that is above the established market rate, it is time to re-negotiate. By lowering monthly expenses slightly, the wealthy are able to increase the value of a multifamily residence and add to their level of control.
A Final Word
Once the investor has been able to increase their cash flow, they may believe that they are in danger of being hit hard by taxes once it comes time to sell. Some may decide to milk their newfound cash cow for all it is worth before passing it down to their heirs. Others may want to sell and receive the biggest possible bang for the buck.
Use a 1031 exchange in these instances. This defers taxation until a follow up purchase is made. Those who use these exchanges repeatedly avoid taxation until they die. That is how the wealthy use real estate to increase their level of control and their level of income.