Why People Buy Real Estate

1. Positive Cash Flow

2. Appreciation

3. Depreciation

4. Mortgage Pay down

5. Leverage

1. Positive Cash Flow

When evaluating an investment property, cash flow is determined by comparing income and expenses. Cash flow represents the profit you earn each month after collecting all income, covering all operating expenses, and setting aside reserves for future repairs.

For buy-and-hold investors, cash flow is essential for increasing their income.

It enables them to invest in additional properties, build a financial safety net for expenses, or use the surplus funds however they choose.

2. Appreciation

Appreciation occurs when a property's value increases over time.

For a property owner, a higher property value can result in a profit when the property is sold in the future.

Quick tip: The U.S. Federal Housing Finance Agency provides a calculator to help estimate these numbers more accurately.

3. Depreciation

Another reason people invest in real estate is to benefit from depreciation, which provides tax advantages.

To put it simply, depreciation refers to the decrease in a property's value over its useful life, allowing for tax deductions. Depreciation begins as soon as the property is available for rental use.

Investors can deduct the cost of purchasing and improving a rental property. Instead of taking a large deduction in the first year, they can spread the depreciation over the property's useful lifespan.

Typically, the IRS calculates depreciation for most U.S. residential properties at a rate of 3.636 percent per year over 27.5 years.

According to the IRS, a property is considered depreciable if you own it (even if financed), use it for business or income purposes, have a determinable useful life, and expect it to last more than one year.

Note that this does not apply to land or landscaping, as land cannot be "used up" and therefore does not depreciate.

To estimate depreciation, you generally need to determine the property's basis, which includes the acquisition cost, legal fees, recording fees, surveys, and similar expenses.

Next, separate the cost of the land from the buildings.

Once this is done, you can calculate the value of the property and make any necessary adjustments.

4. Mortgage Pay down

In many cases, investors are not only earning cash flow but also using rental income to pay down the property's mortgage.

This means that, assuming the cash flow is positive, the property can effectively be acquired at no net cost to the investor.

Let’s compare mortgage pay-down to cash flow. If your goal is financial freedom, then finding deals with strong cash flow is essential.

However, if your aim is to build a retirement fund, then cash flow may be less crucial in the early years.

In this case, you could focus on having tenants cover your mortgage payments, even if you only break even initially.

Over time, even a small amount of cash flow should grow. Your strategy should be to focus on property appreciation and gradually raise rents in line with the market.

For example, if you start with a $100 cash flow per month in the first year, it could grow to around $125 annually, depending on your market, while the mortgage is continuously paid down.

After several decades, your cash flow will increase significantly, and the mortgage will be fully paid off.

Once the mortgage is paid off, your expenses decrease, boosting your cash flow.

Alternatively, you could sell the property and cash out the entire value.

Ultimately, it depends on your overall investment goals. It’s wise to have a variety of rental properties in your portfolio as your goals evolve.

5. Leverage

Purchasing real estate allows you to build leverage for yourself and your business.

The key is to establish a scalable model by implementing effective processes as you expand your portfolio.

D. Voight Thornton, MBA is an Certified Debt Consultant?Mr. Thornton was born in Incirlik Turkey (Adana AFB Base), and grew up in the Southwest (New Mexico). He earned his M.B.A. in Business Administration, Technology Management, while working as an Licensed Mortgage Loan Officer. His interest in the finance lead him to relocate to Arizona, to further his career,?Since graduating, Mr. Thornton? has worked in multiple compliance domains including his FinTech background. Mr. Thornton is licensed in Mortgage and as a certified Debt Consultant in the United States.