4th Dimension: Depreciation/Taxes

By: Mark Frentz
www.akerahomes.com
mfrentz@akerahomes.com

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Depreciation is a Good Thing?

With real estate, depreciation can be one of your greatest assets. Did you know that real estate is, as far as I can ascertain, the most tax advantaged investment in Canada? I could be wrong with this as I don't know the ins and outs of the energy sector and everything going on there, but as far as what the average person can afford and get into, there is no competition. Not only do I receive a monthly paycheck for investing the banks money, or gain from an asset that acts as a hedge against inflation, or have someone else paying down my borrowed money and the interest on that borrowed money... I also am able to pay less in taxes each year because of my investment in real estate.

I would like to warn you at the beginning of this entry that I am not an accountant. What that means is that I cannot offer accounting advice, nor should you base any decision on what I am attempting to teach you on. What you should do is take these ideas and speak with your accountant about them. If your accountant doesn't have any idea what you are talking about or simply shoots down the ideas as terrible, maybe it's time to find a new accountant. The reason I suggest this is that full time (and very successful) investors are using this strategy. If they are using it and your accountant doesn't know or understand the idea, they may not be the right person to work with when it comes to investing in real estate. 

Each property has two parts that you are purchasing: land and structure. The land value goes up and/or down with the market and offers little in tax incentives, but a portion of the structure can be written off as a business expense each year; 4% per year of the remaining value to be mroe precise. I'll give an example:

If you were to purchase a piece of property for 300k and it was determined the value of the structure was 200k, you could write off 8k worth of income in the first year (4% of 200k is 8k). In the second year the remaining value of the structure is 192k, so in the second year you could write off $7,680. In the third year, $7,372.80, etc. You can also write off any of the interest you are paying on the mortgage (remember that interest payments are highest in the first few years of ownership and that someone else is making these payments for you). A third area you can write off is maintenance expenses. There are others, but those are the main three. The beauty of this is that you are only counting the income you make from a rental property over and above all of your expenses. If, after all expenses, you make 5k in cash flow in your first year of ownership, you could write off the entire amount through depreciating your asset. What could you do with the other 3k available in tax breaks? Well, one idea is to write it off of your other income that year (earned income from your regular 9-5 job). Are you beginning to see what I mean by depreciation being a good thing?

Some Ideas to Take into Account

I have briefly outlined an idea here in very simple terms. With taxes few things tend to be as simple as they appear and this is true of depreciating your property for tax purposes. Remember to speak with your accountant!

Something I often hear from people is that if they depreciate the asset at 4% per year, they will have to pay more in capital gains taxes when they sell the property. While this is true, the fact is your depreciation strategy should depend on your overall investing plan and not on fear. If I save money on taxes for the next 25 years and then sell the property, I can always use the money I've kept from taxes in the meantime to purchase more investments. I can also reinvest the money I make at the end of those 25 years and depreciate my new investments to offset taxes. Another ideas is that I may not want to ever sell my property... If it is cash flowing and is finally paid off and I am making a lot of money from the property each month and year, why would I sell it? It doesn't really make sense to sell off property that is giving you money each month without much work from yourself if you ask for my opinion. What I would do is keep each property and will it to my wife and kids. If my kids need to sell off one of their inheritance properties to pay for the taxes from another 4 or 5... are they really going to complain about that situation? They've just been given 4 or 5 cash flowing properties and I don't see that as a negative at all. 

Another idea to consider is how you own the property. If you incorporate and structure everything properly, you can take even greater advantage of real estate investing by being taxed in a lower bracket. You are rewarded for simply owning and renting out houses. Again, talk to your accountant and learn all you can about this so you can make it work best for your individual situation. 

Some people are afraid to make money in real estate. Why? You can make tax free money, so why would you not take advantage of it? I have heard of many individuals who purchase properties that don't make any money because they want to use the property for its tax advantages without having the property eat into those tax advantages. While there may be reasons I don't fully understand, my basic response is: why not make money that may not be taxed while receiving tax advantages in other ways as well? Both paying less in taxes and making more money sounds like a better idea to me. No criticism for those choosing to do this, it simply doesn't make sense to me. I've even heard of people who will purchase property that loses a substantial amount of money each year! Like I said, I've heard some of the reasons, that doesn't mean I understand why someone would choose to lose money when they can make it instead.

I invite your response to this blog. Please make a comment and challenge me or share what you are finding helpful. I'm hoping to begin conversations, not end them by pretending to know all things. Let's talk.

If you would like to learn more about investing in real estate please contact me at the email address listed at the beginning of this article or go to my website at: www.akerahomes.com/investing-in-real-estate.html

3rd Dimension: Principle Paydown

By: Mark Frentz
www.akerahomes.com
mfrentz@akerahomes.com

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What Is Principle Pay Down?

For those who are new to real estate investing... When you purchase a property using a lot of the bank's money, you sign an agreement that you will not only pay back all of the money borrowed, but will also do so with an agreed upon interest rate tacked on which is mostly paid up front. The longer the amount of time that has passed since the beginning of the mortgage, the less your monthly payment of interest and more your monthly payment in principle. I'll give an example to make this clear.

There are two parts of what you owe the bank. Principle and interest. If the bank lends you $200,000 at an interest rate of 4% and you agree to pay it off over a period of 25 years, by the end of 25 years you will have paid the bank a total of $316,702.10. The principle of this was the original $200,000 and the interest was $116,702.10. That sounds bad initially, but I'll explain why it is actually good very soon. Every month of having this mortgage you will have a payment of $1,055.67. Part of this payment is principle and part is interest, but in the first month of the 25 year period you pay more interest than in the last month. The reason why this takes place is beyond the scope of today's blog. I'm simply focusing on what happens in general terms. In the first month of holding this mortgage $666.67 of the total is paid against interest and $389.01 is paid against the principle. In the last month of the mortgage $3.51 of the $1,055.67 is paid against interest and $1,052.17 is paid against principle.

The bank does this in order to make more money up front, which takes away some of the bank's risk. If you own a home for a short period of time, most of your payments have gone toward interest payments and when you move into a new home the bank can begin a new mortgage with high interest payments in the first few years in order to make a lot of money again. This is a great reason to hold properties long term rather than short term. The longer you own a home, the less money the bank is making from you in interest payments.

To summarize in an interesting way... in the first year of your mortgage payments to the bank/lender you will have paid off almost $5,000 of principle. This will basically remain the same for the first few years, but in the 10th year of holding this mortgage you will pay off over $7,000, in the 20th year it will be around $10,500 and in the final year it will be over $12,000.

How Can $116,702.10 In Interest Payments Be Good?

In the paragraph you just read I made a huge error. Did you pick it up?

I said 'you' paid off principle. While this is technically true, a more accurate statement is that your tenant has paid off the principle as well as the interest of each mortgage payment if it is good investment. Isn't that crazy? You have an investment that is not only paying you a chunk of money each and every year (often the cash flow on a good investment is already paying you more than the percentage you receive for you RRSPs or mutual funds), but you also have an investment that is increasing in value at an alarming rate and someone else is paying off your debt! That's crazy! That's magic! That's real estate if done properly.

I love certain types of debt. Debt that is paying me every month with extremely low risk is the kind I like. Realize I am very careful about what the definition of good debt is. Bad debt is when you pay every month. Good debt is when you are paid every month, and I mean every month. If you are paid some months or most months, this is still bad debt.

But what if a property is vacant for a month or two every once in a while, you ask? That's why you need to go back and read my blog on cash flow. If you only consider being paid after vacancy rates are taken into consideration, it means even when the place is vacant for a short period of time you will be paying yourself out of the money you have saved for this very purpose.

Back to my question.... How is $116k in interest a good thing? Because others are paying it for me. What are they getting in return (this is important)? They are getting a basic human need; shelter. They are also having this basic human need met not by being given the basics... they are actually given a safe, comfortable home that is well maintained. This is important. Next door to me there is a property owned by a slumlord. The property isn't taken care of even when the tenants ask for help. If the tenants leave, the landlord simply finds new people to make empty promises to. This isn't good investing. Rather, it is short term thinking for many reasons (but I again am getting carried away with topics outside of today's scope).

How Does Principle Pay Down Make Real Estate Different?

I have told you before I am biased. It's true. I honestly believe other investments cannot touch real estate when it comes to how diverse this particular strategy is in how you take away risk while building wealth. Principle pay down is a major component of how we build wealth through real estate. I have mentioned, and will mention in more detail again, that real estate can't be compared with gold. I consider gold a solid way to save money as a hedge against inflation, but it is not an investment, simply a savings account with zero percent interest. How is real estate better than gold as an investment?

First, when if I buy gold I can't ask for a mortgage on it. Which means I must pay 100% up front every time I purchase gold. Secondly, if I borrow money to purchase the gold I can't download this debt to anyone else. If I offered to rent my gold out to other people for a substantial monthly payment I wouldn't have a lot of replies, and for good reason. Why would anyone rent my gold? With real estate I can both borrow money to purchase the investment as well as charge enough money for others to live in the property to pay down every penny of my original debt plus the interest charged on that debt AND cash flow on top of these advantages (Just wait until after I've blogged every major dimension I can think of... It'll take me months).

While I've picked on gold a bit here, there are other investments that have the same problems as does gold. Stocks are an example. It isn't typically highly leveraged (when it is leveraged, it doesn't touch the kind of leverage real estate easily obtains) and it definitely cannot be rented out for any more than a low sum (with inherent risk). The reason a lender/bank won't take on high debt with stocks is due to the high risk factors. Not so with real estate. Banks have decided it is a low enough risk that they can give anyone with a half decent credit score a ton of money even if the borrower has no experience with managing this type of investment.

What Difference Does Principle Pay Down Actually Make?

 Let's use the example I gave earlier on. If you have properly invested your money and have a cash flowing property, you should already be receiving a decent percentage on your investment simply from rental income. Secondly, over a long period of time you will most likely receive money due to property appreciation. Lastly, and the focus of today's article, you will be receiving another $5k each year on top of rental income in the form of principle pay down. You owe $5k less to the bank in year one, which is similar to putting $5k in a safe, long term savings account. Not only are you making decent money this year and able to spend it, you are also putting a good chunk of change into a savings account that is growing over the long term.

Ok, last question... Why aren't you investing in real estate yet? In just these first three dimensions it should be easy to see that real estate is a fantastic way to build wealth. Not convinced yet? No problem:) I have many more blogs to write that I am sure will argue strongly for real estate over other common investments. Have a fantastic week. I wish you the best in your investing education.

If you would like to learn more about investing in real estate please contact me at the email address listed at the beginning of this article or go to my website at: www.akerahomes.com/investing-in-real-estate.html

The Finishing Touches

By: Mark Frentz
www.akerahomes.com
mfrentz@akerahomes.com

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What's With the Ugly Picture?

I'm not sure what goes on for you when you see this picture. I try to think back about what I would think if I saw this picture before I became involved with real estate investing. I'm guessing I would have thought: Why would someone post a picture like this... it's just an ugly apartment with nothing in it? In fact, it's worse than that because it is in really rough shape right now. While many people might be uninterested in this picture (including the poor quality of the shot and blurring) I get excited when I see a picture like this because I now think very different thoughts.

Who and How Can I Help?

I was introduced to a family a few weeks ago that had an apartment they didn't want any longer. They asked me to help them sell the property as fast as possible. I stated I would do my best and a friend and I have been working to find a contractor/investor who can purchase the property and sell it for a profit. We just found that investor and I'm excited for a few reasons. The first is that win-win situations really do exist in real estate investing.

I just helped a family with a property that was simply sitting vacant for a couple years and was costing money each month to hold onto. The family thanked me for doing my job well and getting the money they were asking rather than having to take a massive loss or lose money each month for the next year or two. I just helped an investor who was willing to could work hard and make a profit from that work. The investor thanked me for providing a fantastic opportunity. I just helped a complex and condo board that had an apartment sitting vacant with a sign on the front door making public that there was a long standing problem. The condo board is grateful to have a clean, well renovated apartment which actually increases the value of the other apartments around it. I also just helped out my own family by providing for them with the work that I do.

So, Who was the Loser?

I love what I do because when I do it properly absolutely everyone wins. I've had a lot of people thank me in the past few days for what I do because I didn't look simply at profit, but rather at how I could offer solutions to problems. I firmly believe that if I become excellent at solving problems more people will win and that's my business strategy. I make friends and solve problems. The reason I am posting today is to offer an example of how business and real estate really can be a good thing for everyone. I have some family members who, when I explain what I do, ask me who loses in the deal. They don't believe my response and, in the end, I have to be ok with that.

I encourage anyone reading this post to think about why they want to invest. What is the ultimate goal? Is it simply to become wealthy? If it is, there is nothing wrong with wealth on its own. Money is simply an idea. What I will propose is that if wealth was the only goal, it wouldn't be enough for me. I can't motivate myself to do difficult things that other people won't do for money alone. Don't get me wrong. I have plans of becoming wealthy. I also have plans of what my wife and I can do with that wealth in the lives of others. What really motivates me day to day is that I really love helping people. I don't understand (and therefore can't see the ultimate value) how stocks help people. The stock market helps businesses and the economy in some respects, but in the end the help is intangible. I love doing what I do because I see the benefits directly in front of me and wanted to share that with you today. Two people I desperately desire to help along the way are my two young children. I want them to grow up understanding there are more options open to them than the average person ever dreams of. I desire them growing up with a mindset of "how can I work toward my goal" rather than "I don't think I can do that".

I hope you enjoy these posts as I share part of my life with you. Hopefully they also provide some benefit as you look to preparing for your own future and that of your family's. Enjoy the rest of the summer.

If you would like to learn more about investing in real estate please contact me at the email address listed at the beginning of this article or go to my website at: www.akerahomes.com/investing-in-real-estate.html to see two of the many ways I find better than MLS listing deals to provide investors with sound opportunities.