By Daniel Goodwin
The fact is that you and I will need income for the remainder of our lives. Most people hope that their savings will one day get them to their destination. Saving is important and is a required part of a well-conceived plan, however saving alone is a losing proposition; we have to learn how to invest. You have to challenge your fears, increase your fiscal literacy, and train or retrain your brain if you have fears about investing and real estate.
For example: If you needed one million dollars for retirement, and were able to save five hundred dollars per month, and could average an eight percent return on your investment, you would find that in twenty-five years of savings you would not have even one-half of the million dollars you set out to save. Moreover, in twenty-five years, the money you managed to save would be worth about 40 percent of its original value due to inflation. You might have to think about marrying someone with money or moving in with your kids. How many people do you really know who have created wealth by saving? Not many, I’ll bet. People create equity and wealth with real estate and investments. Real estate creates wealth faster than other investments because the invested money controls a much larger asset due to leverage.
In looking at leverage, let’s consider that you use $50,000 of your own money to purchase a commercial building worth $250,000. You are using a 20 percent down payment to control 100 percent of a commercial property or rental home. Many people use leverage when buying their home without even realizing their own brilliance! Your situation will soon improve with depreciation. After you purchase the building, a certain percentage will be depreciable. If you are entitled to 3 percent depreciation on the $250,000 building per year, you will have a $7,500 tax write-off. If you are being taxed at a 30 percent rate it will yield a savings of $2,250. Your savings are equal to a 4.5 percent return on your original investment of $55,000 just in the depreciation on the property.
In addition you get the appreciation on the full amount of $250,000. So if the building goes up in value by 5 percent, you will have made $12,500 in addition to the $2,250. Your first year internal rate of return, not counting the value of your amortization or cash flow, would be 30 percent. If you create $10,000 in positive cash flow and your loan balance goes down by $4,000 per year, you could calculate a first-year value on the equity you invested of 58 percent. In short, leverage and tax-favored depreciation are preferred methods of the wealthy, who understand how money really works inside real estate investments.
For the record, I am not a self-proclaimed real estate guru or someone who thinks real estate is the holy grail of all investments, and I am keenly aware that people do lose money in real estate and many other kinds of investments. Real estate is just one component of a portfolio, albeit the most important one. In Houston there are over 107,000 millionaires. While it is difficult to determine the source for this wealth, one study found that real estate contributed to as much as 50 percent of these individual’s first million dollars. I believe there is more opportunity in real estate in America than ever before. America’s population stands at 330 million and is expected to exceed 400 million sometime before 2050. Real estate will be the basis for a staggering amount of all new wealth created as demand for housing, apartments, commercial buildings, retail centers, and vacation properties increases.
A whole new generation, called the echo boom generation, is set to follow the baby boomers. The echo boomers, primarily the children of baby boomers, were born between 1980 and 1994. They represent more than 70 million consumers in the U.S. economy. This generation, along with the 1.5 million new immigrants arriving every year, will create a new wave of demand for virtually every type of real estate investment. You need to be educated and ready to move on real estate opportunities, as they will be most abundant in the years to come. Forget about this week’s headlines and the fear mongering that the newswires feed on; after all, negative news is what sells the most TV time. One thing is certain in any economy: real estate is here to stay, hence the term real estate.