However, real estate is unique in that it has three components of return:
- appreciation in value
- cash flow
- income tax benefits
Many people lose money due to insufficient research and analysis, as well as through unmitigated risk issues. Do your homework before investing in real estate.
Appreciation in value
Most people buy investment properties with the thought that “it will appreciate in value and I’ll get rich.”
Over long periods of time, say 15 to 25 years, real estate seems to perform well and has earned much wealth for many long-term holders. It’s only realistic to assume a real estate asset will experience at least one market decline over this period.
Be aware, though, that appreciation does not pay the bills. It is better to invest based on cash flows, the next noted component of returns.
Cash flow positive
Do your sums, this means putting conservative estimates of rents and expenses down on paper and making sure that the rents, less all the expenses, leave the owner some cash in the bank. We call these “cash flow positive” properties.
Buying properties with true positive cash flow is the best way to ensure that your investment will add to your wealth. Far too many buyers purchase negative cash flow real estate and take additional monies out of their bank accounts each month, for years, to cover the deficit. That is no way to invest your hard-earned capital.
Income tax benefits
There are potential income tax benefits from owning rental properties. “Benefits” means that as a result of your ownership, you pay less in taxes than you would have if you did not own the property. Unfortunately, few investors really understand how this works.
If you are self-employed and pay little in taxes or you have income greater than $150,000, you probably have little tax benefit from your real estate ownership. Before you start banking on the tax benefits you’re going to get from a real estate investment, consult with a tax pro who can tell you whether or not you will actually save a dime.
While all the investment returns may help your long-term wealth, the cash flow component is the most important. Cash feels nice in your hands, it pays the bills and, most importantly, it accumulates in your bank account and earns interest.
If your investment doesn’t generate cash, you won’t be able to pay the mortgage, you’ll likely lose the property and you’ll never realise the returns you’d hoped for.