#6: The 4 Ways To Make Money in Real Estate

Welcome to the Passive Income MD Podcast, where we talk about creating your ideal life through multiple streams of income. I'm your host, Peter Kim. If you enjoy hearing about this stuff, make sure to hit subscribe so I can bring it to you every week. Now let's get on with the show. Hey, everyone. Today we're going to be talking about one of my favorite subjects, and that is how to make money in owning real estate. I think there are four major ways and we'll talk about that over the course of this episode. Before we get there, I want to make a couple quick announcements. Number one, I'm super excited to announce that our second annual conference, Financial Freedom Through Investing in Real Estate, is definitely happening this fall. We've just confirmed the dates and and it's taking place on October 10th and 11th, 2020 in Los Angeles, California. So mark those dates in your calendar. Tickets have not gone on sale yet. Last year they sold out, especially the VIP tickets sold out right away. So we've expanded things. This year we're taking up the whole room and we've added double the capacity. But there's a good chance it could sell out again this year. So make sure you look out for those tickets to go on sale and be the first one to get them. Number two, we're going to be launching another class of passive Real Estate Academy. We only open it twice a year. That's because we spend so much time really with the students to make sure that they feel confident in investing in these passive and private real estate deals like syndications and funds in only four weeks. And after that, we have an investor club that people get put into and we get to talk about these deals afterwards and really help each other with the due diligence and really present new opportunities for each other. So look out for that. That class is going to be open sometime next month. So let's get back to the episode. Today we're going to be talking about four ways to make money in owning real estate. As many of you know, I love using real estate investments as a vehicle to create financial freedom. I think it's an amazing way to create passive income. It's not the only way, but it's my favorite way. It's not a get rich scheme. It takes time, it takes effort, it takes some knowledge. But that's what you're here for, right? To listen to it, kind of hear stories of people doing it. And I have to tell you, I know so many people who have used real estate as an avenue to help create their ideal lives and I hope that works for you as well. Now, one of the major ways to do that within real estate, it's such a broad category, is through direct ownership. And what that means is that you actually own the rental properties yourself and you rent them out to tenants. And most of the times I'm talking about multifamily or apartment buildings, but you own it, you rent it, and you keep this property for as long as you want. Hopefully you'll live off the cash flow for years to come. So let's dive into it and talk about the four different ways. Number one is something called appreciation. This is the idea that the home's value increases over time. For those of you who own your own personal homes, you know exactly what I'm talking about. You know that you bought the home at a certain price, and years down the road, if you decide to sell, you know the price of that home has changed. Hopefully it's gotten gone up in value. But sometimes they can go down in value, but the majority of time they slowly go up in value. And that happens to usually correlate with inflation or maybe the demand of that area. Most people say that typical appreciation rate is somewhere between 3 and 5% of the home's value each year increases. That's kind of called passive appreciation, meaning that you wait, you hold the asset or hold the home, and. And over time the value tends to go up. There's also something called forced appreciation. And that's where an owner can really help drive the increase in the value of the property. And that can happen by improving the property itself and increasing the operations. For example, you might renovate a kitchen or a bathroom or do a great paint job. And you know that that increases the value of the property, right? Maybe if you own an apartment building, you add some amenities there, you change the signage, you change the whole feel of the apartment building to attract a different type of clientele or tenant. You know that that will ultimately do something that's called force appreciation and increase the value as those rents go up. This is one of the major, major levers that operators or people that are professionally owning real estate use to really drive that value. They look at a property and they say, hey, this thing is under managed or undervalued. They and this is what I can do to improve the operations and ultimately drive the price of this and the value of this building up. That's something called value add investing. And you see a lot of people do that. In this case, they're actually really forcing that appreciation by getting in there, getting their Hands dirty and improving things. That's one of the major ways that investors get in there, own real estate and make money. The second is through something called cash flow. And we talked about that before, but it's simply what's left over from the rental income. When you remove or take out the expenses, they're actually paid off. If there's something left over at the end of the day after collecting that rent, getting all the income in and paying off the expenses and the mortgage and the taxes and the insurance and that sort of thing, whatever's left over is something called cash flow. And hopefully that's a positive number. There's a positive cash flow, and that's what ends up in your pocket that you can use if there's a deficit. That's called negative cash flow. And ideally what you do is you'd be able to collect that cash flow and each month and be able to live off it. That's money that gets put in the bank that you can use on your own terms and you can live off of. And that's one of the major ways that investors really look to make money off of rental properties. Now, when people consider investing in real estate, they usually consider those two major ways to make money, right? The value of the building goes up over time and then they get some cash flow from it. But there are two other major ways that you need to absolutely know about. Number three is they make money, three through saving on taxes. Now, owning a property is very similar to being a small business owner. Own a building, there's operations, there are often employees or people that you contract, work out to. And so there are quite a bit of expenses, right, that are a part of it. One of the major benefits that the government gives you in terms of saving taxes is something called depreciation. It's whereby the irs, it allows you to determine the value of the actual building. So you take that whole building value and divide that value by 27.5, and that's the number of years that the IRS has determined that this building is kind of useful for. That's like the lifespan of a building. If you take the value divided by 27 and a half, that's how much you can deduct from a rental property, from a multifamily apartment building every single year. So you can save on taxes for that. Now, with the Tax Cut and Jobs act from the recent Trump administration, there's something called rapid or accelerated depreciation we could take some of. Instead of doing it over 27 and a half years, you can Kind of squash that down over just a few short years in the beginning and get a major tax benefit upfront. Just so you know, that deduction that you take when you go to sell the building, you have to kind of repay or pay a tax on that. And that's something called depreciation recapture. But that is really taxed at like more of like a capital gains, long term capital gains tax rate. And, and if you don't sell that building, then you never really ever have to pay that tax and that gets pushed off. And if you ever decide to pass that along to your family at the time of your death or passing, they don't have to pay that tax as well because they get that new property at what's called a stepped up basis, meaning they get the property its current value. For those of you who follow my blog, you might have heard something called real estate professional status or reps. Now in that type of case, and we'll talk about that in a future episode and in a little more detail. But, but you can take some of the deductions from your rental properties here, which can be significant, especially if you squash that. Instead of doing it over 27 and a half years, you squash it over four or five years per se. You can actually help deduct and offset some of the income that you're getting from your day job. Let's say if you're a physician. And that's something that I'm actually utilizing or taking advantage of this year, is that I'm a real estate professional because of the numbers of hours that I put towards this and some of these qualifications. And at this point, considering the amount of hours that I work as a physician, I'm able to offset some of my day job taxes using the deductions that I get from my rental properties. And we'll talk about that more in a future episode. But just know that that's a significant, significant tax break that you can take advantage of when you own real estate. And then the fourth way is by something called mortgage principal pay down. And what that is is that you know when you buy a rental property, you're usually using a loan on it and that's something called an amortized loan where the payments are kind of spread out evenly over time. For the most part, every month, a little bit of the payment that you make goes towards paying off the interest and some goes towards reducing the principal or the main mortgage amount or the amount that you borrowed. Every month a little bit of the principal is getting whittled down by the rental income that you receive. So in essence, you're gaining more equity in the property as time goes on, it's getting paid off and you're not doing that officially. Your tenants are doing that. Right? The rental income that you receive is going towards paying down that mortgage. Some of it goes to interest, but again, some of it goes to pay down your mortgage. So over time, if you keep the property long enough and you don't change the loan terms and that sort of thing, they're essentially paying off that property for you. And your equity in the property is increasing along with whatever appreciation that you might have. So to do a quick recap, when you talk about investing in real estate and owning rental properties, people oftentimes only talk about the going up in value, right? The appreciation aspect of it. Or maybe they talk about the cash flow. But really, you have to wrap in all four ways to make money. Number one, appreciation, the value going up over time. Number two, the cash flow, the income that's provided to you after all the expenses are paid out. Number three, taxes, the amazing tax benefits that you can get from owning real estate, whether that's offsetting your day job income or or offsetting the cash flow that the property produces. And number four is mortgage principal pay down, meaning that over time, as you keep the property, that property gets paid down by your tenants that you gain equity in that property. Hope that was helpful. Have a great week and see you next time. Enjoy the show. Let me know by dropping a review in the podcast app you're listening to us in. And if you haven't already, make sure to hit subscribe. Are you a part of our community yet? Join thousands of physicians who are also on this journey to creating their ideal lives through multiple streams of income. You can join us on our Facebook group Passive Income Docs and you can always learn more at our website, passiveincomemd.com thanks again for allowing me to be a part of your journey. See you next time.