Does Your Investment Property Still Measure Up?
Posted by business | investment | Posted on January 29th, 2010
The purpose of this article is to give a friendly whack upside the head to people who own rental property. You probably made a good investment when you first bought the property. But have you owned it too long?
Depending on how long you’ve held your property, it might not be a good investment anymore. I didn’t say not a good property; I said not a good investment. Read on to find a simple way to determine if your property is still measuring up. You may be in for a surprise!
First, let’s quickly review the four financial benefits of owning investment real estate:
CASH FLOW: After you pay all expenses and loan payments, cash flow is the money left over.
PRINCIPAL REDUCTION: The loan is paid down with money collected from tenants.
INCOME TAX SAVINGS: IRS rules allow property owners to take depreciation deductions, which shelter the cash flow and principal reduction. Any leftover depreciation creates a paper loss, which, in many cases, can be used to shelter other income — such as salary from your job.
APPRECIATION: Over time, the property increases in value.
These four benefits are powerful! You earn tax-sheltered cash flow, your tenants buy you the building, you get to tell the IRS you’re losing money, and all-the-while, the property goes up in value. What a country!
So why am I challenging you to reconsider whether your property is still a good investment? Simple! Your "return on equity" is probably low -and getting lower by the year!
Let me show you an example. Don’t get all tangled up in the numbers. Just concentrate on the big picture and how it applies to you.
Return on Equity Drops from 18 to 7 Percent
Assume you bought a rental house 16 years ago for $70,000. You invested $10,000 and bor¬rowed the rest. Your goal is to retire in another 15 years and use the rental house to provide retirement income. (A great plan!)
So, how good was your investment 16 years ago? Let’s total your benefits. Assume the cash flow, principal reduction and tax savings added up to $1,800 that first year. You were earning 18 per¬cent ($1,800 divided by $10,000) on your investment. Not bad. Plus the rental house was appreciating. You’re an investment genius!
Fast-forward 16 years to the present. Let’s assume the following: Your yearly cash flow has increased to $5,000 and the principal reduction is $2,000; a total of $7,000 —just from the first two benefits! In addition, let’s assume the net value of your rental house has appreciated over the years so it’s now worth $120,000 and your loan has been paid down to $40,000.
However, because you’ve owned the property so long, the depreciation deductions (assume they’re $3,000) are no longer enough to shelter the $7,000 of cash flow and principal reduction. That leaves $4,000 of unsheltered (taxable) income. Instead of saving tax, you have to pay tax. If you’re in a 35-percent bracket, (combined federal and state), you pay $1,400 tax.
So, your benefits from the rental house now look like this: $5,000 cash flow, plus $2,000 principal reduction, minus $1,400 tax paid. A total of $5,600.
It’s no wonder you consider yourself an investment genius if you measure the $5,600 against your original $10,000 investment: that’s a 56 percent return. But that’s where most people go wrong!
Your Original Investment Has Nothing to Do with Today’s Rate of Return!
Your investment is not the amount you originally invested years ago. You’ve got way more than $10,000 "tied up" today! Your investment is the amount you could get out of the property if you sold it today. That’s called your "net equity."
Over the past 16 years, your property has increased in value and your mortgage has been paid down. The current difference between the property’s net value (after selling expenses) and your mortgage balance is $80,000. In other words, if you sold the property today, you could walk away with $80,000.
However, if you keep the property, in effect you’re re-investing the $80,000 into the property. Now, how does your investment look?
Not so good. You’re earning $5,600 in benefits on an $80,000 investment — that’s only 7 percent! What if a REALTOR® called you up and said, "I’ve got a great real estate investment for you. You’ll earn a measly 7 percent." You’d hang up on them! Well, you already own it!
If you wouldn’t buy a property like that, why would you continue to own it?
What if you did this instead? Use your $80,000 equity as the down payment on a different property — one that produces 18 percent again? With that down payment you could probably afford a $400,000 rental property. Once you’ve owned that property for a few years, your equity will have grown again (and your rate of return has fallen), so you repeat the process.
The goal is to maintain the highest possible rate of return, which will make a huge difference in your future wealth. You’ll maximize your wealth by wisely moving your equity form your currently property to another as soon as your rate of return would be greater in the next property.
Just for fun, take out your calculator and figure how much money you’d have in 15 years if you leave the $80,000 invested at 7 percent. Then calculate what $80,000 invested at 18 percent grows to in 15 years. I could give you the answer, but you might not believe me – check for yourself….it’s gigantic!
Three Ways to Move Your Equity
Here’s a key point. If you decide it’s time to "move your equity," be sure to explore all your options. There are three common ways to move equity.
SELL: You could sell your current property and buy another. The problem with selling is
you have to pay capital gains tax.
REFINANCE: You could refinance your cur¬ rent property and use the loan proceeds to buy
another property. The problem with refinancing is you’re probably not able to borrow the entire
$80,000 equity.
EXCHANGE: The third and best way to move your equity is to exchange. Exchanging
allows you to move your entire $80,000 net equity to another property without paying tax. It’s wealth building’s most powerful tool.
So, what does this all mean? Well, if you own rental property, congratulations. Your investment brilliance shines brightly. However, the longer you own that property your glow begins to fade. The wise thing to do is re-evaluate your property every year. In essence, make the decision to "re-buy" the property. As soon as the rate of return on your equity could be higher in another property, it’s time to take action.
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small cap stocks for fast growth, but it's risky
you won't hardly see any changes investing in large cap stocks
they would probably go down in price as the market corrects itself, but this all depends on bernanke
i would recommend holding in cash, but i dont think that's gonna do you any good
i would recommend DPZ
Thats when you put your money in the care of someone else, in hopes of getting it back in the future. You do this, in hopes of making money in the process.
Its kinda like loaning $20 to a friend and getting $25 back after he or she gets paid.
i think jim is gonna ask jerry to work for him.
You are right not to want to use a broker. I learned that hard lesson several times. Brokers make money from commissions when you buy and sell. That means they profit from 'churning' your account. Some of them have no more experience in picking good companies than you or me. Having a brokerage license has little to do picking great stocks.
You can do better on your own with a good discount brokerage firm. Try some place like Charles Schwab. (not sure if I spelled it right either.). You won't get a full service broker, but they will help you do what you tell them you want to do and it will be a lot cheaper when you do buy or sell stock.
Before you invest, read some books on the basics of making money in the market using tried and true methods that minimize risk and allow you to identify winning companies.
There are many good books on stock investing. The "Motley Fool" books are good, and the Peter Lynch books are good. Do a search on amazon.com and you can see what is available. There will be many reviews of people that have read them sharing their thoughts on each book.
Good luck.
-Kevin
Saving bond and mutual funds. Over time, they will be a significant investment for your child in the long run, even though you don't have a long term goal. Saving bond that you are able to cash after holding it for a year. and Various mutual funds has varies conditions applies to them. That way, you are teaching your child value of his/her dollars!
Don't invest in penny stocks, that's a waste of money. The chance of you hitting it big with a penny stock is the same as hitting a jackpot in a lottery. Invest in stocks of solid companies like Johnson&Johnson, CVS, Microsoft, Ebay, Google…
Make sure to diversify as well. You can use online broker like Scottrade.com or Etrade.com, etc… They give you lots of tools to do research and pick stocks that match your criteria and investment goals.
Good luck
You say that you don't want to "buy" stock, you just want to invest in it? What do you see as the difference? Basically it sounds as if you just want to buy small amounts and watch them, but one word of warning, if you're just buying a little at a time, the transaction fees will kill you. You're best bet is to get into some type of ETF(exchange traded fund), also known as SPDRs, that act like passive mutual funds, they track specific indices that you pick(consumer discretionary, gold, oil, just about segment you could imagine). The great thing is you only pay one transaction fee and get solid diversification, and the maintenance fees are usually less than half what you would pay going through a mutual fund. Once you have your funds picked out, invest all at once, this way you only pay a few transaction fees, which will add up to dividends in the future. Also a good option is called a DRIP(dividend reinvestment plan) which automatically uses your dividends(money you get for free from owning your stocks) to rebuy fractional shares of what you already invest in, but with no transaction fees.
Hope this helps, and happy trading!
A very good means of investing in the US is through a DRIP Plan. And they are inexpensive to start.
DRIP's are seldom talked about because brokers make very little money when they suggest them. Yet, they have proven to be one of the best, if not the best, long-term strategy on Wall Street.
The best part is you get to choose from the best Blue Chip International Corporations in the world. You can have Toyota, General Electric, Royal Canadian Bank or McDonalds in your portfolio. Although there is always risk in stocks, these Blue Chip giants offer far less risk than most.
They are inexpensive to start and maintain, and your dividends are reinvested for free.
They are perfect for small investors, as well as big investors. They will allow you to sleep at night and not care about whether the market is going up or down.
Good Luck
i use sharebuilder.com, or etrade.com. if u don't want to invest online visit a dow jones company and ask them about stock options or partial shares they are easy to try.
Actually, there are quite a few companies already created that collect money to invest in foreign countries. They are called mutual funds. Many of these are traded as stocks on stock exchanges. Now here is the really good part. Many sell at discounts to net assets. Here is a link to a site where you can learn about all of these including their investment track record, what countries they invest in, the discount they are trading at, the expense ratio they charge, etc.
http://www.etfconnect.com/
My favorites are the ones investing in China and India where the economies are growing much faster than in the U S. And they are on sale currently at about a 12 to 15% discount to net assets.