If you’re looking into real estate investments, you likely want to earn wealth on real estate based on risk you are taking, while minimizing the amount of time you need to spend attending to the property. In order to accomplish this, you need to make some smart choices upfront when buying investment property. Your goal should be to strive to get as close as possible on as many of these optimal scenarios as possible:
Pays a Fair Cash-on-Cash Return
When you buy property you are taking money out of your liquid financial assets – stocks, bonds, CDs – and investing it into a very illiquid asset – real estate. You were earning a rate of return on your financial assets, such as 4 percent or 6 percent, and you should strive to earn a fair cash-on-cash rate of return on your real estate. To do this, you need to pro forma your deals and buy cash flow-positive properties that earn you decent returns – not those prize properties that are negative, negative, negative. For more guidance on this, see Smart Investing – A Tale of Two Town homes.
Isn’t Too Risky an Investment
All real estate is extremely high risk. Development of real estate, land, Tenant-In-Common (TIC) investments, private real estate funds, fixer uppers, etc., all have much higher risk profiles than just simply buying a nice established cash flow investment property. In many of those investments, you will never see a dime of your money again because there are just so many things that can go wrong! So if you want to own real estate, consider simply taking fee simple title in your own name – or an entity you wholly own – to the properties you purchase. In addition, you must do the proper due diligence, analyze, test, review reports, etc., to make a lower risk real estate decision.
Doesn’t Require a Lot of Time or Managing
Some properties just require way too much time and management to make them smart investments. Examples include vacation rentals, low quality properties in bad areas, college rentals, etc. Nice boring properties rented for as long as possible to decent credit profile tenants seem to take the least time to manage. In addition, treating your tenants fairly and with respect goes a long way towards keeping good relations with them; and reducing your hassles when there is an issue you need to address. And believe me — there will be issues!
It’s the nice, boring, wholly owned, in good shape, cash flow-positive properties that are the best investments. They are out there for your picking, but it’s not as simple as finding a property on the MLS and buying it.
You need to do some hard work, research, read up, and make smart, educated decisions to acquire the best real estate investments!
As entrepreneurs find success with their primary business ventures, many search for the proper investments for their profits.
Of course, we can and should all start traditional tax preferred vehicles like an IRA and 401k. These are the bedrock of good 'benefit' planning for ourselves and our employees. I'm also convinced more entrepreneurs should consider rental real estate as an important part of their portfolio.
I realize many business owners shrug off this concept after the recent downturn in real estate values, but let me list a few reasons that may change your mind:
1. Gain more leverage. Real estate is one of the few investment vehicles where using the bank's money couldn't be easier. The ability to make a down payment, leverage your capital, and thus increase your overall return on investment is incredible.
2. Grow, tax-free. Buying rental property based on speculation of its value is a dangerous tactic since cash flow is the key. However, appreciation over the long-run is certainly realistic and at the least you should be considering a tax-deferred strategy. In the future, you may even consider a 1031 exchange, charitable trust, or an installment sale to lesson your tax liability further.
3. Tax free cash flow. It's no secret that because of depreciation and mortgage interest deductions (if you leverage your capital), your cash flow should be tax-free. That's right! The far majority of the time an investor will never pay taxes on their cash flow and can wait for capital gains on the sale of the property in the future.
4. The tax write-offs against your other income. Depending on your classification as an Active Investor or Real Estate Professional and your income level, there is a good chance your rental property will not only give you tax-free cash flow, but an overage of tax deductions you can use against your other income. With that said, this is something you want to discuss with your tax professional before investing so your expectations are realistic.
5. Increased tax deduction strategies. Rental property affords investors with another incredible opportunity to convert personal expenses to potentially valid business deductions. Don't forget that rental real estate is a business. This means that travel expenses to check on your properties and payments to family members who manage your properties (such as students away at college) can be deductible and increase the tax benefits when it comes to cash flow and the future sale of the property.
6. Rental real estate is a forced retirement plan. Americans are terrible savers. We lack the self-discipline to put a monthly deposit into our IRA, SEP or 401k as small-business owners. However, buying a rental property is a significant commitment that you are required to commit to and maintain. You will always be grateful in the long-run when you don't give up on it and build future cash flow and wealth.
I meet with a lot of successful entrepreneurs, and almost every one of them has taken profits from their businesses over the years to invest in rental property. Based on this fact and the list above, I have consistently urged my clients to buy one rental property a year and already have clients with rental properties earning them money they never imagined they'd have.
The far majority of us will never get rich overnight. It takes long-term investing and a diverse portfolio to build true wealth. Don't forget real estate as an important part of the equation.
Pays a Fair Cash-on-Cash Return
When you buy property you are taking money out of your liquid financial assets – stocks, bonds, CDs – and investing it into a very illiquid asset – real estate. You were earning a rate of return on your financial assets, such as 4 percent or 6 percent, and you should strive to earn a fair cash-on-cash rate of return on your real estate. To do this, you need to pro forma your deals and buy cash flow-positive properties that earn you decent returns – not those prize properties that are negative, negative, negative. For more guidance on this, see Smart Investing – A Tale of Two Town homes.
Isn’t Too Risky an Investment
All real estate is extremely high risk. Development of real estate, land, Tenant-In-Common (TIC) investments, private real estate funds, fixer uppers, etc., all have much higher risk profiles than just simply buying a nice established cash flow investment property. In many of those investments, you will never see a dime of your money again because there are just so many things that can go wrong! So if you want to own real estate, consider simply taking fee simple title in your own name – or an entity you wholly own – to the properties you purchase. In addition, you must do the proper due diligence, analyze, test, review reports, etc., to make a lower risk real estate decision.
Doesn’t Require a Lot of Time or Managing
Some properties just require way too much time and management to make them smart investments. Examples include vacation rentals, low quality properties in bad areas, college rentals, etc. Nice boring properties rented for as long as possible to decent credit profile tenants seem to take the least time to manage. In addition, treating your tenants fairly and with respect goes a long way towards keeping good relations with them; and reducing your hassles when there is an issue you need to address. And believe me — there will be issues!
It’s the nice, boring, wholly owned, in good shape, cash flow-positive properties that are the best investments. They are out there for your picking, but it’s not as simple as finding a property on the MLS and buying it.
You need to do some hard work, research, read up, and make smart, educated decisions to acquire the best real estate investments!
As entrepreneurs find success with their primary business ventures, many search for the proper investments for their profits.
Of course, we can and should all start traditional tax preferred vehicles like an IRA and 401k. These are the bedrock of good 'benefit' planning for ourselves and our employees. I'm also convinced more entrepreneurs should consider rental real estate as an important part of their portfolio.
I realize many business owners shrug off this concept after the recent downturn in real estate values, but let me list a few reasons that may change your mind:
1. Gain more leverage. Real estate is one of the few investment vehicles where using the bank's money couldn't be easier. The ability to make a down payment, leverage your capital, and thus increase your overall return on investment is incredible.
2. Grow, tax-free. Buying rental property based on speculation of its value is a dangerous tactic since cash flow is the key. However, appreciation over the long-run is certainly realistic and at the least you should be considering a tax-deferred strategy. In the future, you may even consider a 1031 exchange, charitable trust, or an installment sale to lesson your tax liability further.
3. Tax free cash flow. It's no secret that because of depreciation and mortgage interest deductions (if you leverage your capital), your cash flow should be tax-free. That's right! The far majority of the time an investor will never pay taxes on their cash flow and can wait for capital gains on the sale of the property in the future.
4. The tax write-offs against your other income. Depending on your classification as an Active Investor or Real Estate Professional and your income level, there is a good chance your rental property will not only give you tax-free cash flow, but an overage of tax deductions you can use against your other income. With that said, this is something you want to discuss with your tax professional before investing so your expectations are realistic.
5. Increased tax deduction strategies. Rental property affords investors with another incredible opportunity to convert personal expenses to potentially valid business deductions. Don't forget that rental real estate is a business. This means that travel expenses to check on your properties and payments to family members who manage your properties (such as students away at college) can be deductible and increase the tax benefits when it comes to cash flow and the future sale of the property.
6. Rental real estate is a forced retirement plan. Americans are terrible savers. We lack the self-discipline to put a monthly deposit into our IRA, SEP or 401k as small-business owners. However, buying a rental property is a significant commitment that you are required to commit to and maintain. You will always be grateful in the long-run when you don't give up on it and build future cash flow and wealth.
I meet with a lot of successful entrepreneurs, and almost every one of them has taken profits from their businesses over the years to invest in rental property. Based on this fact and the list above, I have consistently urged my clients to buy one rental property a year and already have clients with rental properties earning them money they never imagined they'd have.
The far majority of us will never get rich overnight. It takes long-term investing and a diverse portfolio to build true wealth. Don't forget real estate as an important part of the equation.