Mark Kohler breaks down how rental properties generate returns through appreciation, mortgage paydown, tax depreciation, and cash flow. A $100,000 property with $10,000 down and 5% appreciation yields 50% cash-on-cash ROI. He covers the 750-hour rule to qualify as a real estate professional and use losses to offset other income.
Chapters
There's four benefits to rental property. There's appreciation, mortgage reduction, tax benefits and cash flow. Now, in my master real estate analysis spreadsheet, in fact, here's another bonus. If you email me Mark at Martj Kohler and type in the subject line Real Estate analysis spreadsheet, I'll send you a pretty elaborate spreadsheet I use to even analyze my own real estate deals. And I send it out to clients on a regular basis. I'm going to make sure and ask that you subscribe to my newsletter and my social media to stay in touch with me. But I'll give that to you for free. Now in my spreadsheet I have these four calculations to figure out what your ROI return on investment or cash on cash return is going to be with a rental property. So you should be able to knock this out. So let's just do it quick. Let's say I buy $100,000 property, I put down 10,000 in cash, that's my down payment. Here's PP, my purchase price and I get a mortgage for 90. All right, you can add zeros to this or whatever, but this is the concept and I have lots of clients that buy $100,000 rentals. Not in Southern California by the way. Alright, so I've got this now $90,000 mortgage, 10,000 cash down and $100,000 purchase. What's that property going to go up in value over time? National Real Estate, national association of Realtors and we've seen this across the board over the last 50 years. Real estate appreciation outperforms S&P 500 real estate grows in value. Now there's ups and downs. I lived through the 20 billion 2015 crash or sorry 2009 crash. I've been there. It's brutal. I got, I get it. But we, we know that it's going to go up in value. So if I can just give up 5% and there's markets that have done 10% or greater every year. If I say the property is going to go up by 5%, what is, what's my return? Do I get 5% on the cash or 5% on the property? Well, if I buy a property for $100,000 now, next year should be worth $105,000. Now I'm not dealing with taxes or sales, cost of sale, but that property went up by five grand went up by five, I invested ten. So I divide the five by the ten. I just made a 50% ROI. I invested ten, I made five, and that's tax deferred Maybe even tax free mortgage reduction. Someone's paying the mortgage for me. It's called P I T I Principal interest, taxes and insurance if I can. And that. Whoa, whoa, whoa. Oh, there we go. Okay, that just fell. We still good sign. Okay, so we had that on a little stand there. Principal, interest, taxes, insurance. If my tenant can pay PITI then I break even on that property. Now. Yeah, you want to reserve vacancies, damage, HOA fees, property management and all that in my spreadsheets. I like to analyze that. But if I can at least cover these that property, the value is going up and the mortgage is going down. Let's say the mortgage goes down by $2,000 in a year because most of the payment's going to go to interest. So if the mortgage goes down by two, look what happened. I made more money and appreciation and the mortgage went down. I'm building equity and I didn't put any more money in. So a $2,000 benefit of more equity turns into 2,000 divided by 10. 20% ROI then tax benefits. The sexy part. This is where we're going back to this page. This is what we're going to come back to this page because of this quadrant. I got to put it in perspective for you. Rental real estate loses money on paper. Even though we're cash flowing, even though it's appreciating. I'm losing money on paper. And why is the big D and I don't mean Dallas, don't mean divorce, I mean depreciation. I love depreciation. So I'm going to be writing off here's a building on this piece of property and I'm going to be writing off this building on this property in 27 and a half years. I may even do a cost seg and I can really ramp up the depreciation. Plus I get to write off the interest that the tenants paying taxes, insurance, cell phone, travel, dining, entertainment. Oh, not entertainment anymore. What a bummer. All these write offs are going to be playing out here. The average rental loses $6,000 this year. We'll do over 3,000 rental properties on tax returns with an average loss of six grand. Well if I'm in a 30% tax bracket, 25 fed five state and 30% of six grand means I got a $6,000 write off. So I'm going to pay taxes. Less taxes of 30% of that. That means I just saved 2,000 in taxes. People, this is important. Buy a rental, pay less in taxes. Isn't that crazy? It's because the pass through Losses offset our other income. If you qualify as a real estate professional, it can even be better. But in the self rental and Airbnb and variety of strategies, I can get a full write off for this loss against my other income. That's the beauty of this strategy. So 2000 divided by 10, I made 20%. Wow. Now cash flow, let's say just this thing, cash flow is an extra hundred bucks a month. Just 100 bucks a month of cash flow that I didn't have before. 100 bucks, that's 1,000 a year. Let's say I'll even round down $1,000 a year in extra cash flow divided by 100 grand. A $10,000 investment. I made 10% so people in the first year I made 50%, 20%, 10, 50, 60, 70, 80, 90, 100% return, 100% ROI in the first year. And I'm just getting started. So the more effective we can be with this strategy, the better. And we as advisors and as real estate investors want to know how can I take advantage of this quadrant Because I want tax free cash flow, tax free cash flow and I want mortgage reduction with no extra money out of my pocket and that appreciation I can take advantage of down the road, we're going to come to those strategies. So on this right side, when it comes to the losses, because that's what I'm talking about now you say, well Mark, don't I get a write off of all those losses? You just told me it depends on the type of rental property you own. If you own a long term rental. I have to be a real estate professional. A real estate professional is a three part test. It's not just two. I have to, if I don't, if I'm not a real estate professional in my trifecta, all those rental losses, they go into a bucket and they carry forward. If I'm a real estate professional, all of those losses are deductible against my 1040. Real estate professional means I work 750 hours a year in real estate. Now I could be a full time dentist or doctor and do 750 hours. That's 13 hours a week doing real estate. But I also have to be in the primary occupation of real estate and managing a tree farm. I don't think as all the regs I've read doesn't qualify as a occupation in real estate. So primary occupations, real estate. And then this is also I have to materially participate, meaning I have to be involved in the real estate to some degree. And there are seven tests to qualify under here. So those are the three ways that if I'm a real estate professional, I unlock all those losses. Now, if I don't unlock them, it's okay. So many people go, yeah, my accountant said I don't get the losses, so I don't do the real estate. Oh, whoa, whoa. This bucket will grow. And anytime you sell any rental property, you can dump out these losses. Even if the losses came from property two, three, and four, I can use the loss against property number one.
