The benefits of real estate investing I

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Real Estate Investors
The benefits of real estate investing I
By
Dec 15, 2006, 23:55

Detail analysis of real estate investing benefits.

Appreciation

Real estate values have experienced a steady increase in value for the last several years. This appreciation is due to the overwhelming demand for real estate. Besides serving as a basic human need (shelter) that everyone on the planet must satisfy, several other factors are working to increase the demand for real estate. For instance, the vast majority of baby boomers (the 85 million Americans born between 1946 and 1964) are approaching their retirement age and are buying, in record numbers, second homes— condos in the city or vacation properties in the mountains or near the ocean. The echo boomers (78 million in total—the children of the baby boomers have just begun to buy their first homes and rent their first apartments. Immigration accounts for approximately 1.2 million new inhabitants of our country' each year and will continue to do so for the foreseeable future. Immigrants (especially Hispanics) tend to have more children than native-born Americans; thus, our country's population will continue to increase from within. In fact, the estimated population of the United States by 2050 is 420 million. That's a staggering 42 percent increase, while Europe's population will decline by 10 percent and Japan's by 21 percent during the same period. If the U.S. population continues to expand at these rates, the demand for available housing will, logically, increase as well. The divorce rate has passed 50 percent, forcing both parents to buy homes instead of living in a single property. People are living longer (70, 80, and 90 years of age is not uncommon), and the elderly will continue to apply additional pressure on the current housing stock. All of these factors will continue to create significant demand in the housing market during the coming years.

Leverage

Leverage is the use of borrowed funds to finance the purchase of an asset. Leverage allows you to use other people's money (often referred to as 0PM) to buy more properties, and real estate investors use leverage to increase their purchasing power and finance investments that they cannot pay for otherwise. Leverage also allows investors to earn a higher return on their equity. For example, leverage allows you to buy a $1 million property with only $200,000. How else could you buy a million-dollar asset for 20 percent down? In fact, you can buy most properties for much less. If the property appreciates in value by 10 percent in the first year, it will be worth $1,100.000. If you don't use leverage (you buy the property in cash), your return on equity is 10 percent. If you use leverage (say 20 percent down or $200,000). then your return on equity is not 10 percent but 50 percent ($100,000/$200,000). You'd be hard-pressed to generate a return of this magnitude by investing in mutual funds.

You can extract money from the existing value (the equity) of your properties and use it as a down payment to acquire more rental units. When I first began investing in real estate, I couldn't imagine how investors saved 20 percent of the purchase price for a typical $400,000 property. How was it possible to save $80.000? Ask any successful investor if he managed to sock away the requisite funds for a down payment by working 9-to-5. and he'll probably tell you that he leveraged his existing home or income-producing properties to buy more properties.

I happened to leverage the equity in my primary residence to acquire my investment property. I doubt that most people would be able to save S80.000 from their day job for the down payment—forget about it! Successful real estate investors use as little of their own capital as possible to acquire as much property as possible. Keep your hard-earned money for emergencies, and use the bank's money to finance new acquisitions. Very few, if any, investment vehicles compare to real estate in terms of cash-on-cash return. Real estate allows you to leverage your current holdings to take possession of extremely valuable assets. Leverage is the key ingredient that makes real estate the most profitable of investment choices. With $40,000, you could buy a $400.000 property using an 80 percent first loan for $320,000, a 10 percent second loan (often referred to as a piggyback loan) for 540,000 and your own 10 percent down payment. The $40,000 down payment might come from the equity you have in your primary residence or another investment property, thus making this a zero-down acquisition. You never had to use your savings to buy this S400.000 asset! In many cases, you can find an aggressive bank or lender that will provide you with even better terms. (Financing terms are a bit more strict for commercial properties—buildings with five or more apartments.) If the property appreciates by 10 percent each year for three years, it will then be worth $532,400. You have increased your net worth by $132,400 in only 36 months. Try duplicating these results by contributing to your company's 401(k) program—it will never happen.

You must remember this one key strategy to secure your financial success in the early days of your investing career: there is good debt, and there is bad debt. Knowing the difference is absolutely critical. Good debt is used to buy real estate and other assets that tend to appreciate and make money over time. Bad debt is used to acquire liabilities such as cars and boats. These items are very nice to have and make you feel good, but they also immediately lose value and do not appreciate over time. Use debt wisely to buy more of the former and less of the latter.