Step 1: Understanding Property’s 4 strategies to Wealth Creation.
So I’m sitting here watching as the wealth of nations is rising around my very eyes. I’m seeing land, houses, apartment buildings and office blocks going up into the skies. And I’m thinking that understanding property is probably a valuable piece of knowledge.
Are you too wishing you could be one those landed, rich, fat-cats who can sit back and collect a nice stream of passive income?
Are you looking to get into property?
Are you like me, thinking that would be great but I have no idea where to start?
Well come with me now. I have no idea, but we’re going to find out and take that first step to the life of the wealthy, landed mogul. Or at least learn about how to earn investment income from property.
Lesson 1: The 4 strategies to Wealth creation
There are basically 4 ways to build wealth through property. They are through:
- Cash-flow – income from property rentals.
- Appreciation – income from increased value.
- Amortization – value creation through renter’s pay-down of your loan.
- Tax Savings – savings through incentives and write-offs
This basic intro to property investing was mainly outlined by Bigger Pockets’ Brandon Turner via YouTube. You can check them out here.
Understanding Property – Why real estate?
1. It’s Real
Property is a great investment because it is real. You can see it, feel it, walk around on it and know that it has ‘real’ value. You can own it as a piece of dirt, build it as a house, develop it commercially and utilize it as a means of income or production.
Real estate is real and as there is a limited supply of it, against an ever rising population, the market is therefore generally going to appreciate. It is one of those solid, good old investments that give more than just monetary value. Property provides capital, ownership implies strength and influence in an area.
2. Great Returns
This one probably should be first. I know, I know, as much as we might want to avoid sounding shallow and greedy, the true motivation for investing is the money.
We want the money – simple and easy.
And property is simple. It’s easy to understand and it’s so common that it’s generally easy to action. (So I’m told.)
Also, returns are generally predictable. If you run the calculations right, you can predict fairly accurately what returns you are likely to get. (Here I’m relying on the experts – but I’ve researched a few.)
Based on that research, if we do it properly we can fairly well predict a stable return of around 10% plus on rental property.
“Average annual returns in long-term real estate investing vary by the area of concentration in the sector. Average 20-year returns in the commercial real estate slightly outperform the S&P 500 Index, running at around 9.5%. Residential and diversified real estate investments do a bit better, averaging 10.6%. Real estate investment trusts (REITS) perform best, with an average annual return of 11.8%.”Investopedia
With experience and effort there is the opportunity for higher returns, and I have heard of such crazy figures as high as 100-200% I’m not sure about that, but as you come to bigger property flipping deals I’m sure the rewards can be very lucrative indeed.
So the returns are worth looking into this type of investing.
3. It’s Improvable
Real estate is not the only game that offers returns. However, one of the big advantages is that real estate is also improvable.
As stock market investors we are often annoyed that we have no power over the companies we own. We don’t have the capital and therefore influence of a Warren Buffet, or a major owner. We have a tiny share that we expect will perform in a reasonable, predictable way.
However, we have no say how the company will decide to move ahead. We cannot effect the price by tweeting, like say Donald Trump. And so we are pretty much at the will of the powers that be.
With property on the other hand, we can choose to improve it. If it’s empty land we can build on it. We can improve the infrastructure and facilities on the property. We can paint it, plaster it, furniture it and make it look and smell nice. And so we can have a real impact on our investment and therefore improve the value of it.
4. Leverage and Taxes
Another serious advantage of property is the access to leverage and tax assistance.
If you own property, the bank sees this as a real and seriously valuable asset. The bank will then allow you to use this asset as leverage to borrow huge amounts of money. This gives you a huge advantage to multiply your capital and accelerate your investment growth and progress on your mission to success.
This is an area I need to start to become an expert in. We started really passive and safe, but now we’re looking for ways to accelerate.
The other area I need to start to understand is taxes. However, the basic concept makes sense. If we set up our investments as a company, then we can have huge control in the reporting of income and the calculation of taxes. Add to that, the ability to write-off expenses and take advantages of special programs and incentives, then we are looking at saving money on tax. This kind of operation is not at all possible as an income employee. So the increased power and advantages of tax control is a big advantage.
Here I’m no expert (see disclaimer below). However, I know others are taking advantage of both leverage and tax breaks – so I’d be stupid not to look into it.
5. It’s Diverse
As a current investor, moving into property allows us to diversify our investments. Given our limited initial funds we began with stocks, however, as we’ve grown that money into something a bit bigger we can now afford to scale up; moving a large portion of our money into property while we maintain our strategy of regular investment in the stock market. This decreases our risk, as we own two different classes of asset. They are not all tied into the same thing, and therefore will not likely be effected the same way by disruptions.
Further to this, there is huge diversity across the asset class of property. So as we begin to invest in property we can diversify across the range from raw undeveloped land, to rental units, houses, commercial leases, office blocks, hotels and so on.
This brings us nicely to the 4 generators of property wealth.
Understanding Property: 4 Wealth Generators
1. Understanding Property : Cash-flow
Income from property rentals.
The first and most obvious investment in property, for us, was the wealth creation through rental income.
Very simply, you buy a property, with your own money or with a loan, and then you rent it out for a set amount of money, over a set amount of time.
This could be something as small as a unit, to something as large as a shopping mall.
You own the property and you let others use it for a fee.
Obviously if the fee you charge is higher than your costs for keeping the property, including maintenance, taxes and vacancies, then you will make a profit.
Understanding property here is simple and obviously a great investment decision.
What holds many people back from rentals is the lack of knowledge. They don’t know all the variables and that is a big problem.
Things like finance costs, taxes, legal responsibilities, and so on can all be complicated things that can cause serious worry.
Another issue is vacancies. There is the big fear that if you go and buy the property, you will incur a huge debt and a huge regular liability to make repayments, and then what happens if no one wants to rent.
This is a problem that is holding us and many others back from having a go at rentals.
However, as we’ve started understanding property, we’ve started to learn some solutions to this problem.
Firstly, with research we can understand the factors that lead to rental demand and we can find the right area that has high demand and position our investment in an area that has a real need.
Secondly, learning from the experience of others, we can factor in an expense for vacancy into our property valuations, so we are prepared for vacancy and we can make smart decisions without just letting the fear stop us from acting.
At the end of the day, I rent as do many of you. I am paying for someone else’s investment. This shows me that there will always be people who need to rent property and people have been making a fortune doing it for centuries.
So it’s something worth investigating further into in the future.
2. Understanding Appreciation:
The second big wealth generator from property is income from increased value.
Very simply, you buy a piece of property at a certain price and then over time you sell it for a higher price.
If the price you sell for is higher than fees, expenses and taxes, then you make a profit.
The amount of time depends on the deal and your mode of operation.
You could buy a piece of empty land, hold it for ten years and then sell at an appreciated price to make a simple profit.
However, you should always account for taxes and expenses. Holding a piece of land for a period of time will cost you money. Even if you do nothing with it. This needs to be added into your calculations – how much is land taxes and rates and maintenance of infrastructure.
Furthermore, for the more sophisticated investor, you should factor in opportunity cost. Holding that piece of land for ten years may make you a profit. But if you could have made twice as much profit from investing in stocks, then the land is a poor option.
Fix and Flip
Another option is to buy, fix and flip. In this scenario you buy a piece of property, take the effort to improve it in some way and then you can sell it for a higher price.
The downside of this option is that it is a lot more active. You need to do the deal quickly, put in the work, most likely needing to negotiate and supervise contracted workers, and then arrange another deal to sell. This is a lot of work. I can see once you get used to it, it would become a lot easier and more profitable. However, for a first deal in property, it seems a bit more difficult and active than what we are looking for.
There are also risks, and you need to research a lot to truly understand the factors that will drive property value up for a specific target buyer.
But the take away point is, that investors have been using this strategy to make money for centuries. It is also possible to combine rental wealth creation with value appreciation and take advantage of both forms of wealth creation.
There are thousands of options, and once you start to know what you want and you start to look, you will find the little area that feels right to you.
3. Understanding Amortization
The next aspect of wealth creation Bigger Pockets points out is Amortization.
This is where the property owner uses leverage (or a loan) to purchase property and then that property is rented out. The rents received on the property go to paying off the loan.
So even if there’s not a lot left over as profit, the loan is being paid off and once it is completely paid off, you have effectively created an asset worth a whole lot. You own it but someone else has paid it off for you.
And even if you don’t wait for them to pay it off completely, the part they do pay off is equity to you, so you can sell the property and take that equity as profit once you pay the bank for the loan.
This is clearly an excellent investment option. It can work from anything, from a unit to an office tower. However, you need to have access to leverage. If you can arrange the loan, and you can arrange for the property to be rented at the right price so that you can pay down the loan while covering all expenses including interest and taxes, then this is a great way to create long term wealth.
The obvious downside is if you can’t get it rented, then you have to pay down the loan. If you can’t pay down the loan, then interest charges will kick-in to make this investment a very costly liability.
So you need to be certain you are in a position to take on the loan and you’ve done very good evaluations and you can make a good deal. If that all goes well, then you have a great investment option.
4. Understanding Property: Tax Savings
The final area that Bigger Pockets outlines as a generator of wealth is through savings wealth.
When we make money we have to pay tax. As employees, most of us get a wage and there is nothing we can do about the amount of tax we pay. We might be able to think up some deductions, but generally we’re in a tax bracket and that’s what we pay. And generally, the more you make the higher level you pay.
However, if you have a business, such as a real estate business, there are many savings available through incentives and write-offs.
This is an area I need to learn a lot more about. But things like depreciation and expenses can be manipulated to influence the amount of taxable income you report.
This is a lesson for a future date. As we get involved we will need to learn from working with accountants.
Property is one of the cornerstones of wealth creation.
It’s real and it holds its value over time. Like oil and gold, not like cash.
This is because of simple supply and demand.
“God ain’t making anymore of it!” Here I’m quoting Tony Soprano, though I’m sure he didn’t come up with the idea.
Either way, there is a limited supply of land (on planet Earth) and an increasing demand from an ever increasing population. Therefore, it’s a solid investment.
This simple understanding was what drove the power and influence of the landed classes and will continue to in the future.
Don’t simply get sucked into the old lie that it will always go up, or that your family home is your greatest asset – learn to become an owner, a landlord, – build wealth, power, influence, become successful on a whole higher level.
You need to decide what level of understanding property you are interested in and go forward step by step.
For us, it looks like small scale property is a good place to start. We can generate profit from property appreciation. It’s easy and it’s passive.
The first step is to look for property that is undervalued and look to see where there is growth potential and an area that is developing. Before we get started we need to learn a lot more about property research and property valuation. We need to start to learn about tax and finance costs and so much more. However, we’ve found a strategy we can handle and so we can’t let all the problems hold us back. We can learn and we will.
Property is a good step to scale up your wealth creation, learn this easily understandable concept and keep striving for more and more success.
To learn more about investing your way to a successful life read How to Achieve Financial Freedom through Investing.
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