Real estate and wealth go hand-in-hand. Andrew Carnegie is credited with stating nearly a century ago that “90% of all millionaires become so through owning real estate.” Owning real property has always been a cornerstone in building and retaining wealth in a free nation. Why? If it is a farm, business or rental property, the real estate produces cash flow for the owner to help build wealth. It is a way to passively make money without using personal labor, or trading ‘time for dollars.’ If the real estate is your primary residence, it enables you to obtain shelter and retain wealth; you avoid paying someone else for that service (except the tax man, of course).
In a society that uses paper or a flat currency, which includes all nations today, real estate like gold, silver and all hard assets is a way to retain wealth by preventing loss of your money to inflation, the most powerful risk to eroding wealth today. But, unlike most other hard assets, you can borrow money to purchase real estate and, if done prudently, turn inflation into a benefit – leveraging inflation can actually help you build great wealth.
To remember the many financial benefits of this asset class, I say that rental real estate is the ‘IDEAL investment.’ Each of the five letters in I.D.E.A.L. stands for a unique advantage, and I show how each contributes to a combined annualized investment return of 30% on a typical single family rental home where you invested a conservative 25% down payment in 2017:
- ”I” stands for income. My goal for gross income generated by a rental property is 1% of the purchase price, which results in solid positive cash flow after covering costs and the mortgage payment, and these rents should go up with inflation over time. Average Annual Return: 6%
- ”D” stands for deductions (from taxes). All expenses are generally able to directly offset taxes from being paid on rental income received, with the two largest deductions being mortgage interest and depreciation (he building on your land depreciates in book value each year and you can deduct this ‘paper loss’ from your gross income). Average Annual Return: 6%
- ”E” is for equity buildup. You build equity by using rental income to pay down the loan balance taken to purchase the property. This investment return is in addition to the net cash flow in “I” above. Average Annual Return: 10%
- ”A” is for appreciation. Appreciation can result from inflation or increases in demand for property or improvement to the property. Assuming the property appreciates only due to inflation and you had simply bought it with cash. Average Annual Return: 4%.
- ”L” is for leverage. You borrowed 75% of the money to purchase this rental property but received 100% of the appreciation, magnifying the 4% return to become: 16% that first year, and a 30 year Average Annual Return: 8%.
As you can see, prudent use of leverage provides one of the largest contributions to total return on rental real estate investments. You get the benefit of all 100% of the appreciation over time even though you put up only 25% of the money; you maximize returns by leveraging other people`s money (OPM). In 2017, you can borrow 85% of the purchase price, and with the strategies we teach at Paradigm Life you can borrow the remaining 15% from an insurance company, pushing the rate of return much higher.
Meanwhile you have been able to reduce asset risk and diversify across several rental markets. If you’d like to find out more about using a Wealth Maximization Account to fund your real estate portfolio down payments and dramatically speed up your wealth creation, please contact your Wealth Strategist here at Paradigm Life.