Unique Benefits of Real Estate
1. Leverage: You can use debt to acquire larger properties and increase your cash on cash return in properties with positive leverage. [I’ll explain these terms in detail later in the report].
- Residential: Up to 90% Loan to Value
- Commercial: Up to 75% LTV
- Apartments: Up to 80% LTV
2. Insurance: If it burns down you can rebuild it, often with income while re-building.
3. Depreciation: You can depreciate the value of the building over the course of 27.5 years for residential and 39 years for commercial. This helps shield income from taxes. Using cost segregation you can sometimes accelerate the depreciation.
4. Income: You can rent the property and collect income and this happens regardless of shifts in the market.
5. Tax Deferral: Using a 1031 exchange you can defer taxes when trading like kind properties. “Like-kind” simply means real estate in the USA held for business or investment purposes.
One of the main reasons to use debt is to create positive leverage. Positive leverage exists when the cost of money [your interest rate on your loan] is lower than the return on your investment. This is also known as a “cash on cash” return. Your cash on cash return is calculated by dividing the income by the actual cash investment [ex. downpayment].
You buy a $500,000 apartment with a 7% return.
Scenario #1: Pay Cash: Your cash on cash return is the same as the return on investment, 7%.
$500,000 invested, $35,000 annual income = 7%
In scenarios #2 and #3, the interest rate on a loan is 5% with a 30 year term.
Scenario #2: 50% Down: Cash on cash return goes to 9%
$250,000 invested, $22,500 annual income = 9%
Scenario #3: 25% Down: Cash on cash return goes to 11%
$125,000 invested, $13,750 annual income = 11%
As you can see, using positive leverage in this current real world scenario can take a 7% return and bump it up 57% to an 11% return.
To download and view the entire 2014 Portland Real Estate Market Report, click here.