Posted On: Friday, May 26, 2017
With the volatile financial markets of the past three years, wise investors are looking for alternative vehicles for their wealth. Real estate investments offer five profit centres:
1. Market appreciation
2. Earned appreciation
3. Positive cash flow
4. Mortgage reduction and leverage
5. Tax deductions
Compare this to stocks, which have just two profit centres: dividend and capital gain. However, to make a wise investment it is important to understand how each of these five profit centres work to maximize the opportunity for gain.
Market appreciation is the gradual inflation that increases real estate values over time. In the last 50 years Canadian residential real estate has increased steadily by six per cent per year. Over the past 44 years commercial real estate has increased by seven per cent. These are average Canadian figures, but they illustrate that real estate generally rises over time. The purchasing power of money drops over time, so investing in an appreciating asset is a sound way to maintain and grow your wealth. This is even more pronounced if an investor buys in a down market.
Earned appreciation is one of the most powerful aspects of real estate. Real estate increases in value when it is renovated and upgraded, even in bad times. The potential of earned appreciation depends on the purchase of a run-down or antiquated building. It cannot be achieved by buying a new and impeccable property. Again, you cannot add a basement suite to your mutual fund and create extra value.
Positive cash flow is when rental income exceeds all expenses and a cash surplus remains at the end of each month. This eventual accumulation of cash will enable the wise investor to buy more properties and eventually achieve financial independence. The ideal real estate investor always expects cash flow to be tight initially, but as rents rise with inflation and mortgage rates on the property remain the same, cash flow increases. It is this gap between the rent and the mortgage that increases cash flow.
Mortgage reduction and leverage: When a property is bought using a bank loan, this debt is eventually paid off by the tenants rather than the investor. Your best partner in a real estate deal is a sound tenant. A good tenant looks after the building and helps you pay down the mortgage with his rental contribution and walks away with no financial interest in the building. If your mortgage is amortized over 25 years after that time, the property is yours free and clear. So with mortgage reduction and borrowing, even with no cash flow, you still end up owning the property at the end of the day. The beauty of real estate is the ability to secure a loan for at least 65 per cent of the cost, leaving the investor to put up only 35 per cent but allowing him to earn on 100 per cent.
Tax deductions are a profit centre because they enable you to keep more money and boost income.
The key tax benefits of investing in real estate are:
• Depreciation on the building’s cost can be used to shelter cash flow
• Interest on the mortgage is tax deductible if it is an income property.
• Renovation work that can be considered repairs is fully deductible.
• Appliances can be depreciated more quickly and used to offset tax.
In summary, real estate offers an exceptional set of profit centres for smart investors