Income producing real estate is the third leg of our improved stool for financial security (the other two are paper assets and ownership in an operating business). Together, these three legs represent a vast improvement on the traditional three-legged stool of personal savings, pensions and social security.
For the right investor, income-producing real estate can be an invaluable part of an overall wealth creation strategy, but it is not an investment to be entered into lightly. As many investors have found out over the past several years, property values can go down quite rapidly which, in the case of rental properties, can lower rental rates in certain neighborhoods.
Before we continue, I’d like to express what some might consider a controversial opinion: A home is not an investment; it’s a place to live. After expenses such as mortgage interest, taxes and repairs, actual returns on homeownership are modest at best. (I’m not against home ownership, but to have your entire real estate allocation tied up in your principal residence is not what I consider investing.)
Investing in income producing real estate (the key point here is “income producing”) requires the identification of properties that can be bought at a reasonable value; produce spendable cash flow each month; and appreciate at a nominal rate. In my opinion, if you have to sell a property to make a profit it does not qualify as “income-producing.”
There are many types of properties with the potential of producing income including single family homes, vacation rentals, multi-unit apartments, office buildings, medical facilities and hospitality-related properties.
Obviously, real estate investing can be complicated, so it’s critical that you establish goals and have a plan to achieve them in place. It will require a lot of research to identify the best location for your income producing property. You’ll also have to run the financials to determine whether or not the property will provide cash flow (income producing). And part of that process is deciding if you will need the services of a property management company.
When it comes to financials, I do not advocate borrowing large amounts of money (leverage) to acquire properties, even in today’s historically low-rate environment. The amount of leverage you decide to employ should never exceed what you earn in free cash-flow; which leads us to taxes.
As I’m sure you know real estate investing provides many tax related benefits (some of these benefits could change after the first of the year). For example, the ongoing depreciation of properties creates cashless deductions. Also, the ability to do 1031 tax-free exchanges provides flexibility in managing a real estate portfolio. Finally, the income they produce is free from the Social Security and Medicare tax associated with wage income.
I know many advisors, for whatever reason, are not inclined to recommend real estate as an investment for their clients. But owning income producing real estate can be a rewarding and profitable experience for the right client. The key is that it must be part of a properly allocated investment portfolio within an overall wealth creation strategy.
#####
For more on building your financial security, go to Prime, a new offering from TraderPlanet. Click here.
Related Reading …
