The 5 Characteristics Of An IDEAL Real Estate Investment

As you look for ways to make your money work for you, it can sometimes become difficult to find just the right vehicle. Long term “buy and hold” real estate is one of the few truly IDEAL investments you can make to build true wealth.

Consider these 5 characteristics that make Long Term Real Estate the I.D.E.A.L. investment:

I: Income - Your property can produce sizeable cash flow each month when your purchase is structured correctly.

D: Depreciation - Yes, there are significant tax advantages to owning property. You can write off real estate as a depreciating item, even when it actually appreciates.

E: Equity - Each time your tenant makes a rent payment, you are paying down the principal on the mortgage.

A: Appreciation - The national average for appreciate is about 3.4% per year over the last 30 years. As we continue to live in inflationary times, property values will continue to keep pace.

L: Leverage - The ability to use other people’s money to finance your acquisition.

This is not to say that buy and hold is a perfect investment. It is not. If you had bought and held in Detroit over the last few years, you would not have realized appreciation. In fact, your values would have decreased.

Nothing is a perfect investment. Buy and hold is simply the smartest investment you can make…especially when done right.

Let's break down each of the IDEAL characteristics...

Income - It makes sense to your purchase your property in a market with a strong price to rent ratio. That means, but in places where it typically costs more to rent than to buy. Then, even factoring in taxes, insurance, maintenance, property management - you will still have significant net cash flow every single month, and it will be predictable! If you buy a property for $50,000 that rents for $1200 per month, and after all expenses, you net $7500 per year ($625 per month), you just made a 15% annual return on your investment. Where else can you deploy your capital to earn a stable, solid, predictable 15% cash flow, every month?

Depreciation - The IRS allows you to deduct a portion of the cost of your property over time. Defined as "a reduction in the value of an asset with the passage of time, due in particular to wear and tear". Even though in many cases your home is appreciating in value, you are allowed to show a tax write off on the purchase price of your property (price divided by 26.5) which effectively will shield your rental income. Keep in mind, this is a delay in paying the taxes on that income, when you sell the property you will need to recapture the depreciation. But, if you buy and hold the property for many years, you are now keeping and investing that income vs. giving it up front to Uncle Sam.

Equity - If you purchase your property in cash, this doesn't apply, but if you utilize debt leverage, every month your renters are paying down your mortgage debt. So while your property value is going up, your debt is going down - creating faster equity growth and increasing your net worth. The equity can eventually be refinanced and recaptured (often times for further investing), or captured when you sell the property.

Appreciation - This is the least compelling of the 5 Ideals, simply because we do not like speculation, or "buy and pray." We will rarely (if ever) buy a property based on the belief that it will go up in value. We do not have a crystal ball, and markets can be difficult for the average investor to predict. However, over the course of time, real estate has shown a small but overall consistent increase in value typically on a yearly basis. In the markets where we are seeing appreciation faster than the national averages, we look at that as “icing on the cake.”

Leverage – Getting in with a small amount of one’s own money while putting to work a much larger amount of other people’s money (OPM) – allows a multiplication benefit unlike any other investment. If a property is producing a 20% return with a straight cash purchase, and you can borrow money from the bank at 5% interest, that means you are effectively making 15% on bank money! This would be an ideal scenario to borrow as much as you possibly can.

However, if you are making 8% on a straight cash purchase, and you borrow money at 5% interest, then you’re only making 3% on bank money. This scenario has such a low margin for error, that it's probably not worth the risk. If a renter vacates early, interest rates rise (on a commercial note they could in 5 years), or rental prices are forced to drop by market conditions, then you could potentially be over-leveraged and in a negative cash flow situation.

The lesson here is to be aggressive when the margins are strong, and be very cautious when they are tight.

Remembering that Income is the FIRST characteristic, let’s take it one step further. Namely, how can we create PASSIVE income? Passive income should be strongly sought after in EVERY property you purchase. When you acquire properties that are managed by a good property management company, you can effectively sit back and enjoy your ongoing streams of income and wealth generation, with little to no involvement on your part.

Passive income is everyone’s favorite form of income. You can realize ongoing streams of income that do not require any effort on your part. Then you can truly enjoy an incredible lifestyle. You can do what you love to do, when you want to do it, and with whom you want to do it. You can work on the things you love, and not work because you have to! This is truly the American Dream.

Investing in real estate is like a owning a business, without all of the pitfalls. When you own a business, you leverage your time by creating systems that produce wealth through the collective work of others. When you invest in real estate correctly, you are leveraging capital to be able to build wealth in a much safer and more predictable way.