Buying Investment Housing for Equity Appreciation and Cash flow
Why investment housing? Real estate is a basic human necessity. As the saying goes, “Everyone needs a roof over their head”. This is reinforced in the illustration below of Maslow’s Hierarch of Needs. Notice at the very bottom, one of the most fundamental needs is shelter:
This is why our emphasis in real estate investing has always focused on housing rather than the other investing asset classes (self storage, office, retail, industrial, etc). In market downturns, which WILL occur if you are a long term buy and hold investor, these other investments can be more volatile depending on the economic situation.
Buy and hold property produces income in 3 ways:
- Equity Appreciation
- Cash Flow
- Tax Advantages
We will not spend time here on item #3 because we are not tax experts. Please consult your tax accountant for the various ways to use real estate to save you on your tax return. Please also bear in mind that the more sophisticated your portfolio becomes, the more important it becomes to have a tax consultant who personally invests in real estate and stays up on all of the continuous law changes that affect real estate investment. To learn more about the tax advantages available to real estate investors, we have created a space on our site named Helpful Tax Tips with great information from our friend and Rich Dad Advisor, Tom Wheelwright.
Equity Appreciation – Appreciation rates vary from market to market but the general rule of thumb is real estate increases in value over time. Holding real estate long term allows the investor to realize this wealth. In addition, the entire time the asset is being held, your tenant is paying the mortgage for you as well which buys down the loan balance thus increasing your equity.
Depending on your personal investment philosophy, this equity can be used to purchase other assets by either refinancing your property for its current market value or using the cash (tax free) to invest in another real estate. This technique allows are you to continue to hold your original asset and re-sets the appreciation time clock controlled by the amount of cash you decide to take out of the property. Another approach is to sell the property and take advantage of a 1031 exchange in order to “trade up” to a larger asset that yields more cash flow and equity appreciation because of it’s higher value. It’s important to understand that this ‘get rich slow’ strategy can be understood by applying the same principles that you have heard many times in reference to compound interest. The appreciation replaces the interest rate and would be identical if this were applied to just one piece of rental property. The big difference exists when you continue to add doors and trade up into more valuable assets using OPM (other people’s money – in this case, your tenants). This adds an exponential effect to the concept of compounding.
Cash Flow – In order to get a more thorough understanding of this topic we would suggest you read the book “Rich Dad Poor Dad” by Robert Kiyosaki. There are several nuggets in his book that completely changed our thinking about real estate investing. If you’ve read any of his books he often refers to getting out of the “rat race” (your job) which relates to a game that he and his wife Kim created called Cashflow 101® .The object of the game is to create enough passive income streams to finally exceed your living expenses. At that point, you have gotten out of the rat race and into the fast track for wealth. In our discussion above about equity appreciation, we mentioned purchasing an asset so the tenant could pay the mortgage. Taking it one step further, we want the tenant to not only pay the mortgage but also all of the expenses leaving residual cash to put in your pocket. This is referred to as positive cash flow. In addition, there is neutral and negative cash flow. Obviously, it’s important to do these calculations BEFORE acquiring an asset in order to ensure that the investment is going to have positive cash flow. (Most REALTORS® do not know how to do this.)