Investing in real estate is a great way to obtain cash flow and/or capital gains while you have someone else pay your mortgage, but there are also other benefits that you may not have thought about when investing in real estate.
1. Cash Flow
Cash flow is the income that is generated from the rental income after expenses have been paid. This is money going directly into your bank account every month — like an extra pay check. This can increase over time as rent goes up with the market. Historically rental rates have gone up in Hawaii, so potential exists for your monthly cash flow to increase over time as rental rates rise.
2. Capital Gains
Capital gains or appreciation is the increase in the value of the property over time. We have seen prices double in Hawaii a couple of times in the past and all you have to do is to own the property to take advantage of this increase. This is an added benefit of owning a real estate investment.
Using leverage to invest in real estate is a benefit that cannot be attained with other investments. For example, when purchasing stocks it will cost you $200,000 to buy $200,000 worth of a particular stock. When purchasing real estate, you could purchase a $200,000 investment property but only need to pay cash for 20% ($40,000) of the total property price. If prices go up 5% in this scenario, the increase in value to both the stocks and the property is $10,000, but with a real estate purchase, your only cost is an upfront investment of $40,000 to have the property value increase by $10,000, whereas with the stocks it cost you $200,000 to make the same $10,000.
Even if real estate is a high-cost investment, less out-of-pocket is usually required to purchase an investment. This all depends on your borrowing qualifications with a financial institution. The amount of cash that each individual buyer needs to have on hand to purchase a property all depends on their personal borrowing qualifications with a financial institution, and the best thing to do is to talk to a loan officer to find out your buying power and to set out your options.
4. Inflation Resistance
Since your monthly mortgage payment is fixed, there is inflation resistance with real estate. Goods and services go up in price, but your monthly mortgage payment does not. You may actually increase your income when you raise the rent over time for your renters and not for you.
5. Tax Incentives
The not so obvious benefits are the tax incentives: depreciation, business expense deductions, investing tax-free with self-directed IRAs and my favorite, the IRC (Internal Revenue Code) 1031 Exchange. In an IRC 1031 Exchange, an investor is able to sell their investment and buy other, like-kind investments, tax deferred.
An example of this is a client of mine who had a free and clear property that was in the family since the 1960s and had been rented out for years. If they sold the house and tried to take the cash, they would have been liable for huge capital gains since the property was originally bought for $60,000 and would sell for over $1,000,000 in today’s market. They would have had to pay taxes on the $940,000 capital gains, minus any improvements and monies that went into the property throughout the years which would have hurt any bank account, big time.
Instead, the investor took all of the cash and invested it in a few other properties, tax deferred, to not only raise their monthly cash flow but to diversify their real estate portfolio and position it to take full advantage of long-term appreciation.
You may have a similar scenario — or a totally different one. If you would like to better position your real estate portfolio to take better advantage of the next, up and coming market, let me help lay out your options using my experience with real estate investments and knowledge with 1031 Exchanges.
Have questions about Maui’s real estate market and need expert advice? For all of your Maui real estate services, please contact Michele Muir White R(S), ABR, SFR Coldwell Banker Island Properties, Wailea 808.298.8448, e-mail: firstname.lastname@example.org Access the Maui MLS www.Maui RealEstateGuru.com