THE IDEAL INVESTMENT

Why Real Estate?

One way to describe the benefits of investment property is by using A.D. Kessler’s acronym “IDEAL”. Typically, when investing in income-producing real estate it generally provides the following economic rewards, which makes it one of the best investment vehicles available to us over the long term as well as a great inflation hedge.

IDEAL

“I” represents “Income”. Every month the owner/investor or property management company hired by the owner/investor collects the rents on the property or properties owned. The owner/investor then pays the expenses and mortgage payment. The balance left over is called the cash flow before taxes (CFBT). “I” also represents inflation hedge. Real estate is one of the best hedges against inflation that is the protection against loss in the purchasing power of the dollar. Undoubtedly, government efforts to control inflation will continue, but owner/investors generally anticipate that some degree of inflation has become a permanent way of life.

“D” represents “Depreciation” today, which we call cost recovery. Our tax laws require us to write off the cost of the improvements such as the building over what’s called the recovery period in what we call a paper loss, which is a bookkeeping entry. This required paper loss is allowed even though the property may be growing in value. It creates a tax shelter today through the operational stage of ownership, but also creates a gain (profit) for tax purposes at time of disposition dollar for dollar in the amount, that was required to be written off. This tax-advantaged investment uses depreciation expense to shelter income “cash flow” from the property investment, which today can make part of the income tax-free.

“E” represents “Equity build-up”. Equity build-up is the reduction of the principal amount of a mortgage, which you may experience in the same manner if you are a homeowner making monthly installments. A little of each payment reduces the amount owed on the loan, so when the property is liquidated the owner/investor owes less against the property.

Equity build-up, works much in the same way with investment property as it does with your own home. In fact it works better, because when the tenants of the investment property pay rent these funds can then be used to repay the loan.

“A” represents “Appreciation”. Appreciation is the increase in value. In real estate investments it can come from several sources. The one most people are familiar with is due to inflation. Real estate has proven to be an excellent hedge against inflation as we already mentioned. Besides inflation, appreciation can take place through what we call forced inflation, which can happen through the efforts of the owner/investor. This is possible by making certain improvements to the subject property and in return by increasing the income, or by decreasing the expenses by practicing sound property management techniques that can justify added value.

“L” represents “Leverage”. Leverage is the use of other people’s money. In real estate leverage tends to maximize the benefits, basically because it allows the owner/investors to buy and control more real estate with little dollars. In other words you don’t have to pay cash for an acquisition of investment property. The purchase is acquired with as little of the owner/investors own money as possible and the balance is financed. By using leverage the owner/investor is able to increase the rate of return on the cash invested.

Deferred Exchange

By combining these benefits and with the use of Section 1031 of the Internal Revenue Code, the owner/investor has the opportunity to “PAY NO CAPITAL GAINS TAX” at time of disposition. Through what’s called a “deferred Exchange” the owner/investor can dispose of their business or investment held property over a holding period and acquire other business or investment held property and defer both state and federal income tax based on their gain (profit) allowing the owner/investor to acquire more real estate. This process will create wealth much quicker because a hundred percent of the proceeds not just a percentage will be used for reinvestment purposes. In order to achieve this favorable process of disposition without making Uncle Sam your partner, the transaction must be set up through a professional “Qualified Intermediary” who is in the business of facilitating these types of transactions. This professional must be in place before the closing of the relinquished property can take place.

By making use of the compounding effects that the benefits of real estate can offer as an investment as well as the benefits of a deferred Exchange, it makes for a sound investment vehicle that any owner/investor can take advantage of today.