Making Money in Real Estate

Making Money in Real Estate. Though most investors already know it, there are four ways to make money in investment real estate. The most well-known, of course, is cash flow. But let’s take a look at all four:

Cash Flow
Appreciation
Amortization
Tax Shelter

The checks we send our clients every month more than cover the costs they incur. This monthly payment is, simply put, cash flow. One of the first things that Edgington Management does when beginning to work with a new client is to identify the rent that we will charge on the properties that our clients seek to acquire. The rent is a key variable in identifying the return on the investment. Once the likely rent has been determined, we consider the initial investment. Then, taxes, insurance, vacancies, management costs, repair costs, etc. are calculated to arrive at our Net Operating Income (NOI). Cash flow, expressed as an annual total, is NOI less debt service. When we understand all the variables we can predict your monthly cash flow for properties of interest. Cash flow is the amount of money that you make every month after paying all costs.

Appreciation is the equity that you build as your home becomes more valuable through time. This is an ongoing, long-term gain. Historically, appreciation of real estate keeps pace with the Bureau of Labor Statistics’ officially-stated inflation rate.

Amortization

Amortization is the equity gain from paying the principal portion of your monthly mortgage payment. Though not considered part of cash flow, it is an important consideration for investment gains. Of course cash investors will see larger and more immediate gains in terms of cash flow. However, this is offset by the expense of tying up more capital. Also, you would not benefit from amortization which grows over time. A typical mortgage loan payoff (denoted in an amortization table) will result in an ever-increasing portion of your monthly payment going towards principal as the amount going towards interest decreases. You thus build equity more rapidly as you continue to hold the property.

By holding assets over time, and only selling properties when the market demands, we can create long-term wealth. When the market reaches an extremely high price point, we recommend selling to fully capitalize on the investment. Though many agents will urge you to sell your properties, we generally suggest you keep them as long as they continue to profit, which can be for a very long time.

Real estate ownership has proven to be one of the oldest methods of creating wealth that you can pass along for generations to come. It is basic supply and demand. We have a growing number of people with only a fixed amount of land.

Taxes and Accounting

Investors that are looking toward Making Money in Real Estate. We at Edgington Management are not accountants. Edgington Management urges you to seek a certified public accountant when considering the tax shelter that real estate ownership provides. Though Edgington Management is not an accounting firm we are able to explain the benefits of a tax shelter as it relates to your investment. Let’s take a closer look. For a primary residence, you would use IRS Schedule A to itemize your deductions and write off the interest that you pay each year (assuming the use of mortgage financing).

For real estate investors owning property in their own name (as opposed to corporate ownership, such as an LLC), income and expenses associated with rental properties are reported on an IRS Schedule E. The National Association of Realtors has and will continue to lobby for the mortgage interest deduction right for property owners across the country – this is more applicable to homeowners generally, as debt service is considered a business expense for investors regardless of the deductions afforded homeowners.

The tax shelter accorded by real estate investment is primarily from depreciation of your investment properties. Again, consult a certified public accountant when considering depreciation, as well as how much you should depreciate each year. Depreciation is reducing the value of the property each year. This depreciation of your property constitutes a loss that you can deduct from the gains you earn on the property. Consider how depreciation can affect your capital gains taxes on resale and ask your accountant if, and how much, you should depreciate.

Depreciation and 1031 Tax Deferred Exchange

If you are considering making use of depreciation allowances as a method of real estate investment gains (the IRS will automatically assume that you have done so), you may want to consider the advantages of a 1031- tax deferred exchange when you are ready to sell the property. This is a method of deferring the taxes you would incur when you sell commercial properties, mixed use, and certain residential properties through buying new investment properties and deferring the capital gains tax you would have paid into the new property. There are very specific guidelines that must be followed when taking advantage of the 1031 tax deferred exchange method of creating wealth in real estate. We at Edgington Management are glad to explain this in more detail, but we urge you to seek a competent certified accountant before making any real estate purchase.