The current market is not particularly good right now. Home prices are high and it’s definitely a seller’s market. But if you’re willing to buy-and-hold rental properties that generate passive income, you’ll still make money over time. Andrew Syrios, a blogger on
BiggerPockets, lists five good reasons in the form of an acronym: IDEAL
I: Income: Your rental property should allow you to charge enough rent to pay ALL of your expenses (mortgage (if any), taxes, insurance, management fees (if any), maintenance reserve) and still give you some income left over. If not, then the other reasons listed below must be that much better in order for it to make sense.
D Depreciation: The government assumes that a property decreases in value to zero over 27.5 years. The value of the property depreciates, but not the land it sits on. Normally you can only depreciate 80% of the purchase price. If you buy a property for $275,000 (assuming no land value), every year it “loses $10,000 of value according to the government. That means that you can deduct $10,000 off of your yearly income.
Later, when you sell the property, you will need to “recapture” all of those depreciation “losses”, but in the meantime, you get to take all of those yearly deductions against your income. To avoid paying taxes when you sell, you can either do a 1031 Exchange and keep taking depreciation losses, or leave the property to an heir and their basis will start over.
Depreciation rules are complicated, so talk to your accountant for further information.
A related benefit is
mortgage interest deductions. Again, talk to your accountant for details.
E: Equity: As the mortgage gets paid down, your equity in the property goes up. And the nice thing about his is that your tenant is paying down the mortgage for you. It’s not money coming out of your pocket.
A: Appreciation: In the long run, real estate goes up in value. It’s a roller-coaster ride, but in the long run, real estate appreciates. So, even though you have to recapture depreciation losses (see above), there is a good chance that you will sell your property for a nice profit.
L: Leverage: If you buy the property with a mortgage, you’re using OPM (other people’s money) to purchase the home. Suppose you buy a property for $100,000, and put down $20,000. If the property goes up in value by 5%, your return is 25% ($5,000 / $20,000). That is a very nice return on your $20,000 investment. Of course, property values go up and down, but that just underscores that this is a long-term strategy, not for speculation.
In addition, as your mortgage balance gets paid down by the tenant, you can use your growing equity as a down payment to buy more rental properties.
If you’re in the market to buy rental properties, contact us here at WestlakePropertySolutions.com. We are in the business of buying homes, renovating them, and selling them to homeowners (as their primary residence) or housing providers (for passive income).