Many people believe real estate investing to be some of the best investments available. I know I certainly do.
Picking the best type of investment you will be pursuing may be one of the first things you do. It is certainly better than starting to invest and then getting distracted when you see or hear of another type of investment. Chasing the next shiny object often stalls wanna be investors and prevents them from ever investing, so deciding which type of investment is best for you will keep you focused and increase your ability for success.
Job one is when you take the time to identify what exactly you want from the investment. I constantly hear people say they are not fussy they just want to make a lot of money. Wow! What a great goal to stall you dead in your tracks. People who say this usually never make an investment because they have not established expectations. I always say hope is not a strategy and this sounds very much like hope.
5 investment returns to consider
When investing in real estate you have the ability to make as much as 5 different investment returns:
∙ Income: from cash flow
∙ Deductions: Income from tax benefits
∙ Equity: Tenants paying down your mortgage
∙ Appreciation: 50 year national average is 6% per year.
∙ Leverage: Income generated by using OPM.
I always consider real estate to be an ideal investment (I.D.E.A.L.) as it is capable of producing all 5 wealth building principles.
Like myself, most of the investors I work with like to capture all 5 of these wealth building principles.
Not all investments of course will do this. For example, if you buy and pay cash you lose the leverage aspect. Of course everyone’s objectives are different, what is yours?
Are you an active investor, such as a flipper or a wholesaler? If so, you must be active in the day to day process of the investment.
If you are a passive investor, you tend to not be involved in the day to day grind and instead are getting paid month in and month out for the diligence you did up front, such as the buy and hold or buy and rent investor.
Establish your niche. What are your realistic expectations?
Passive investors can earn income from buying and holding from the positive cash flow from your tenants. Active investors who are flipping or wholesaling miss out on this recurring benefit.
Tax benefits, when properly used, can benefit you big time; passive (rent and hold) investors can deduct interest payments, depreciation as well as all cost associated with the business. They may also be able to defer capital gains taxes when they sell using a 1031 tax deferred exchange. Active investors (flippers and wholesalers) can deduct their cost of improvements and holding costs.
Passive Buy and Hold investors love this one as they can capture this for the full duration of ownership. This is most often considered the best wealth building principle of them all and one that has made many millionaires. For the buy and hold investor, this tends to be your top objective (next to actual positive cash flow of course), but often the person looking to build equity growth through appreciation will settle for less cash flow if property has a stronger ability to grow in value.
Active investors capture appreciation of course. This is essentially (manufactured growth) and it is typically through the value-play of converting the property to highest and best use which provides the appreciation. This appreciated value tends to be the primary benefit to the flipper. The wholesaler also benefits from this but primarily because the flipper recognizes the benefit from buying this from them as they have done the work to find the properties.
Equity build up is when tenants pay down your mortgage, so this one is only for the buy and hold investor who utilizes leverage.
Both active investors and passive investors can utilize leverage. The ability to borrow other people’s money and capture the full return off of this borrowed money is one reason real estate investing is favored over other investments where this is not plausible. Wholesalers typically do not use leverage as their ability to find the great deals is by paying cash. However through the use of private funds that are established in advance, they too can gain from leverage.
Active investors doing wholesaling and flipping can capture 3 of the wealth building principles while the passive investor can obtain all 5 wealth building principles.
The big difference comes in the holding time. If you buy and quickly sell, you lose the long term benefits of each of these wealth building principals. Passive investors enjoy these benefits over and over long term and they simply continue to compound.
Each investing category has their benefits and perhaps their challenges, finding the niche that works for you that accomplishes your short and long term goals (as well as of most interest you) is paramount. The key, of course, is to always master your niche before attempting another
Seasoned investors who have mastered their skills have learned to navigate back and forth as the market dictates which strategy will work effectively in the current market within a defined location. These active investor strategies can be used to create quick chunks of cash to allow for more passive investments.