The 9 Benefits of Investing in Real Estate: 1. Leverage

Real estate can be a great investment opportunity. Real property and real estate tend to build value and real wealth over time, which produces a return ON and OF your initial investment in multiple ways. We will take a simple look at the power of 1) leverage, 2) appreciation via inflation, 3) consideration of real interest rates, 4) depreciation (for tax purposes), 5) principle paydown of loans, 6) cash on cash returns from cash flows, 7) tax-free cash-out refinances (or equity stripping) when appropriate for business purposes, 8) tax deferral through 1031-like kind exchanges and 9) finally the step up in cost basis to heirs at time of death.

I want you to understand the impacts of leverage. In other words, using $20,000 to control a $100,000 asset or using $200,000 to control a $1,000,000 asset. It is so much easier to borrow $1,000,000 than it is to save it! You can control a massive asset with a very small amount of money. Consider that as you invest $200,000 to acquire a $1,000,000 real asset, the bank partners with you and provides the remaining $800,000. A tenant partners with you to pay back the $800,000 to the bank (talk about an employer matching contribution to your 401k, huh), and the government is partnering with you to allow for tax benefits because you are taking on a job they do not want, which is providing housing and taking a risk. The result is that we are leveraging and partnering with others to make you a multi-millionaire over time. You are leveraging the system established in 1913 on Jekyll Island. You are in essence transferring the wealth of others to yourself because you are using the economic output of others to relinquish your debt; the very same way the politicians and bankers are leveraging our economic output as a country to pay off the debts of our nation (that they have created) to become a prosperous nation.

However, leverage can be a double-edged sword and you need to buy the right assets and have the right tenants, or you could get into trouble. Banks can and do change the rules as they see fit when the economy shifts. For example, requiring more money for a down payment, pre-payment penalties for paying off a loan early, visual valuations dropping resulting in calling a loan (commercial) due or not renewing without bringing more equity to the table, or any other unforeseen issues. For our purposes, we want to understand “leveraging” a large loan (banks), someone else’s income (tenant), and government leverage in the form of minimized taxation against a property with a minimal investment or equity position.

As an investor who is not going to owner-occupy a property (i.e. you’re not going to live in it), banks generally require a 20% or more down payment or a certain debt coverage ratio. Thus, a $100K house would require an investor to put $20K down (+ closing costs), while leveraging the banks 80% or $80K to buy a $100K investment property or a loan of $800K on a $1M investment property. In other words, you can control a $100K asset with just $20K or a $1M asset with just $200K and so on. Why would anyone do that? Who wants all that debt? Who would want someone else to contribute to their creation of wealth and retirement nest egg? It is this very concept that keeps many donating to Wall Street just to get employer-matching contributions. While it seems like free money, you are giving up the use of your capital for the best years of your life. So that others can receive actual fees while you work. Furthermore, while you get to defer a little bit of taxes by “reducing” your immediate taxable income, you will most certainly get taxed when you pull your funds out in 40 to 50 years when the tax rate will most certainly be higher. Get more leverage with real estate with bank debt, tenant principle paydown, IRS advantaged income that can potentially never be taxed! Hopefully, if you understood the leverage, taxes, and wealth-building power from this chapter, then you will be screaming, “I want millions in debt as long as it creates positive cash flow!”