Last time, we covered the kinds of properties you need to look for ‒ the properties that will serve you well as long-term investments. We finished with the numbers from an actual property that fits these criteria. Here’s what we saw:
(This was for a newly constructed property worth $158,000 at time of purchase.) The owner made a 25% down payment of $39,500, and the property generates a monthly cash flow of $417.
The bottom line: after the first year, when you add cash flow to the property’s additional value due to appreciation, you get a $12,904 return on the initial investment of $39,500 ‒ an annual ROI of 33 percent.
But there’s more to this than just the cash flow and appreciation (as good as they are)…
For one thing, the tax benefits of owning rental property are substantial.
Here’s just one example of how this can work. This is for a property where you haven’t purchased it through a retirement account (there can be additional tax benefits if you do purchase it that way).
You get to write off the depreciation on the house over a period of 27.5 years. Officially, you consider the house to be worth eighty percent of the property’s value, and the land the other twenty percent. (You only get to write off the depreciation on the house.) Here’s an example:
Start with a $150,000 home80% of that is $120,000$120,000 x 3.63% depreciation = $4,356 deduction
Next, we’ll assume you’re in the 25% tax bracket…
$4,356 x 25% tax rate = $1,089 tax savings (“in your pocket”)
Even better, you can take this deduction all the way up to $25,000. (At that point, they cap you, unless you’re a real estate professional.) So, again, if you’re in the 25% tax bracket, that’s an extra $6,250 in your pocket just in terms of tax deductions ($25,000 x 25% = $6,250).
The Power of Other People’s Money
Remember, you make an initial investment in your property with your capital ‒ but as soon as you’ve got tenants, they’re the ones fueling this investment’s “cash flow engine.” It’s someone else’s money that’s giving you a LOT of benefits…
For this example, you’ve made a 25% down payment on a $158,000 rental property. We’ve laid out the cash benefits you’re receiving in terms of cash flow, tax reduction, principal reduction, and appreciation (five percent in this case). Then we’ve expressed each amount as a percentage ROI in terms of the initial amount of $39,500. Here’s how it looks:
Notice that with principal reduction, somebody else is using their money to pay back your loan. They’re paying your mortgage for you, on your behalf. That’s real money in your pocket: you take out a loan, and you get to enjoy what the loan bought you (the house, in this case)… but you don’t have to factor in the repayment as coming out of your pocket. It comes out of your tenants’ pockets.
And when you add everything up, you get a whopping 40.5% annual ROI! I’ve said it before… that is simply incredible.
The Rule of 72
A question a lot of people ask is, “What’s a reasonable rate of return?” Well, let’s answer that in terms of comparing what we’ve been talking about with real estate investing versus some more common rates of return, like three to five percent.
To do this, we’ll use the “Rule of 72.” This is a quick way to determine how long it will take to double your investment at a given rate of return. All you do is divide your rate of return into the number 72.
So, at three percent, you get: 72 ÷ 3 = 24. In other words, at three percent ROI, it will take you 24 years to double your investment.
So the Rule of 72 is a powerful tool to help you see the time value of money at work. In the table below, we’ll use it to show what a massive difference even a few percentage points can make in how quickly your retirement assets can grow (not to mention what happens when you really ramp up your ROI). We’ll also show where your assets are at the 20-year mark.
We’ll start with an initial portfolio value of $200,000.
As you can see, there’s a world of difference between a three percent return on your investment, and an eight percent return. It’s the difference between taking 24 years to double your investment, versus just nine years ‒ and between being at $364,151 after twenty years, versus $1,201,830.
And that’s just eight percent, not fifteen or twenty…
Bottom line: it’s so important to get the best return possible on your investment. And given what we’ve seen in this series of articles, I would say that a mere three or five percent return is not “reasonable” at all. Fifteen, twenty, and beyond ‒ I’ll take that any day.
Wrapping It All Up…
Here’s a final example that pretty much summarizes everything we’ve been going through in this series. It’s a somewhat bigger property than we’ve been working with so far ‒ I want you to see what can happen when you start scaling up a bit (remember, it’s just like Monopoly©)…
These numbers are for a newly constructed 4-plex worth $450,000. We’re going to put 25% down, and I figured three percent appreciation because that’s a good number for this property type.
Here’s how it looks:
When you do it right, investing in real estate is a powerful way to massively (and safely) leverage your capital. It’s not rocket science, either. Remember Fran Tarkenton’s quote: “An idiot with a plan will always beat a genius with no plan.”
I’m not saying you’re an idiot ‒ just that you don’t have to be a genius to play the real estate investing game… and win big.
Start playing to win today: Give us a call at (801) 990-5109 or schedule your free appointment here to begin your personalized Wealth Plan. We’ll do everything we can to help you implement the strategies we’ve covered in this article and the whole series. You’ll get truly expert advice and coaching… so you can reach your financial goals by investing in real estate.