As a young investor you may be more concentrated on the growth in capital value; whereas somebody in their golden years can be more focused on creating income. Property is one asset class that does both, increasing in value and generating income. It is often known as the IDEAL investment.
IDEAL is a Simple acronym that highlights only some of the key advantages of owning property:
- Income – One of the important advantages of property investment over several forms of investments is its inherent ability to create passive income. When investing in real estate the crucial thing is to concentrate on net income. Many real estate agents will quote gross return amounts i.e. the yearly rent as a percentage of the property cost. Whilst this is a fair indicator of your potential return on investment, I prefer to concentrate on net yield or net income. You absolutely have to have net positive cash-flow otherwise you have not obtained an investment on your hands but a liability that is debatable. The challenge in property investment is to minimize the down payment whilst at the same time generating positive cash flow monthly.
- Depreciation – A rental house is viewed as a depreciable asset the same as a car or part of factory machinery. Rental properties with positive cash flow may demonstrate an accounting loss, granting the owner a tax deduction, or, as Robert Kiyosaki calls it, Phantom Cash Flow. Depreciation is an accounting loss and just shows up on paper. It could result in you having the ability to turn a tiny economic profit into a little tax loss. So, though you might be losing money on newspaper you could actually be earning monthly cash gain.
The building value of residential property is generally depreciated over 27.5 years. Industrial real estate is generally depreciated over 39 years.
- Equity Build Up & Expenses – As you repay the principle of the mortgage loan you are slowly building up your equity stake in the house. So, even if there’s absolutely no increase in the value of this property within the term of the loan you still end up getting an asset with 100% equity at the end of the mortgage term.
Expenses such as Property management fees, maintenance, insurance, mortgage interest etc., are deductible from the rental income, thereby lowering your tax liability.
- Appreciation – your advantage should appreciate in value with time. Often the largest aspect of a return on an investment in real estate is in the appreciation in the value of the asset and the consequent gain in equity. Property prices can sometimes decrease in the short term because of changes in demand, access to finance, etc over the long term you will profit from appreciation.
- Leverage – Leverage is the principle of using a small amount of your own money to control a large value asset. Among the unique aspects of real estate over other investment Classes is the ability to borrow around 80% or 90% of the purchase cost of the asset. This is leverage i.e. with Other People’s Money (OPM).