EP #15 - How Rental Properties Make You Rich (And Help You Retire Early)
Mar 01, 2024Episode 15
Jacob Sandoval
This episode dives deep into the multifaceted world of real estate investing, breaking down the four essential components—cashflow, appreciation, loan pay down, and tax benefits. Jacob uses relatable metaphors and practical examples to demystify the complexities of real estate, empowering listeners to harness its wealth-building potential. Whether you're a beginner or seasoned investor, this episode provides actionable insights to navigate the journey towards financial freedom with confidence.
This episode dives deep into the multifaceted world of real estate investing, breaking down the four essential components—cashflow, appreciation, loan pay down, and tax benefits. Jacob uses relatable metaphors and practical examples to demystify the complexities of real estate, empowering listeners to harness its wealth-building potential. Whether you're a beginner or seasoned investor, this episode provides actionable insights to navigate the journey towards financial freedom with confidence.
If you don't own any rental properties, you've probably asked yourself why so many rich people invest in real estate. When you buy real estate, how exactly is it making you money and bringing you closer to financial freedom? In this video, we're going to be diving into all those questions and more. Let's hop into it. Now the strength of real estate as an investment comes from the fact that it's making you money in multiple ways. Specifically, there are four ways. That rental properties are making you rich at the risk of being super cheesy. And this metaphor not making any sense whatsoever. Real estate investing is a lot like a symphony where all the different money making elements are blended together to deliver financial harmony. Now stick with me for a second. Cashflow is like the rhythm section providing a steady stream of income. Appreciation adds the soaring melodies as values of your properties increase over time. Loan pay down is like the supporting baseline consistently increasing your equity and increasing your net worth. And last but not least, they all come together for the crescendo of tax benefits. That was definitely cooler in my head. Anyways, let's break these down a little bit further. Now let's talk about cashflow first. So what is cashflow? Cashflow is the profit that's generated from your rental properties, and it's calculated by taking your revenue and subtracting out. All your expenses. Now for real estate, you're collecting revenue in the form of rent. You're subtracting out all your operating expenses like property taxes, property management, insurance, utilities, your maintenance, your repairs, and you're also subtracting out all your mortgage payments. And what's left over when you do that calculation is your profit or your cash flow. Now, if it's a good rental property, that number is going to be positive and what's so important about cashflow is If you have a rental property portfolio, that's generating enough cashflow to cover all your living expenses, you've achieved financial freedom. And that's ultimately the goal, right? The next logical question is how much cashflow should I expect a single rental property to generate? And in my experience, this really depends, but a good rental property should generate anywhere from 200 to 500 in net cashflow every single month after all expenses, I know what you're thinking. 200 to 500 a month is not going to make you financially free. And you'd be right. A single rental property is not going to change your life. Overnight. Real estate is a get rich, slow game, long term ownership of a portfolio of cash flowing rental properties is what's going to help you achieve financial freedom. But also keep in mind, even if the property's cash flowing 200 to 500 today, cashflow increases over time. And the reason why that is is because one, the rents in the United States on average increase. Three to 4 percent per year. Now that's an average and rent increases are not guaranteed, but the longterm trend is pretty clear that rents will increase over time. So that's going to mean your revenue is increasing over time. And the second fact is the biggest expense for a rental property investor is your mortgage. And if you have a 30 year fixed rate mortgage, that means that your mortgage expense is not going to change for the entire life of the loan. So while your revenue is increasing your largest expense, the mortgage. Is staying fixed, which means that your cashflow is increasing over time. So even if it's 200 to 500 now, that's not going to be the same as 10 years from now. For example, this is very important. The vast majority of properties you find on Redfin or Zillow, they just wouldn't cashflow. You have to know how to analyze that deal. Luckily I built a free rental property calculator and deal analysis guide. That's going to help you analyze whether or not a property will cashflow. And you can get that for free in the link in the description below. Let's talk about the second way that real estate is making you rich. And that is. Appreciation. What is appreciation? Appreciation is when the price of something increases over time. And if you've been following the real estate market at all, you've seen that the price and the cost to buy a home has been going up dramatically. According to the federal reserve, about 10 years ago, the median home price in the U S was 250, 000. Today, that price is well over 400, 000. When property values increase, it is benefiting the owner because it's. Increasing the amount of equity that they have in the property. Now, what is equity? Equity is the value of the property minus any outstanding debt. Basically, if you sold the property, equity is what you would receive in the form of cash, less any realtor fees or selling costs, et cetera. So as prices are increasing over time, the amount of money. That owners have in equity is increasing over time. And with equity comes more options. You can borrow against that equity via home equity line of credit or HELOC or via cash out refinance. You can sell to tap into that equity and roll that equity into a much larger property. So the more equity you have, the more options you have. So that's why appreciation can be extremely powerful. Now on average for the past 30 years, real estate has appreciated at a rate of 3%. every single year. It's important to keep in mind, however, that this is extremely market dependent. California, for example, has appreciated at a much higher rate and a much faster rate than other markets in the Midwest, for example. So when you're taking into account of how much appreciation you expect to see, you have to take into account market dependent factors. Just know that appreciation is very hard to predict, but. On average, it's been 3 percent to 4 percent every single year. And because currently the supply of real estate is so low and the demand is so high, it's probably a safe bet that whatever value you're purchasing the property yet over time, that's going to increase. So not only is your property generating cashflow, but the value of the property is also increasing over time. This is the beautiful thing about real estate. The third way real estate is making you money is through loan pay down. Now you're probably familiar with the concept of debt. You borrow some money. Typically from a bank, use it to buy something and you pay it back over time with interest, but not all debt is created equal. Real estate is what we refer to as good debt. Now, why do we call it that? We call it that for two reasons. One, the value of real estate, as we just discussed is increasing over time. So even if we have to borrow money to purchase the asset, the asset is getting more valuable over time. Number two is real estate. Again, as we identified is a cashflow producing asset. So every single month we collect revenue. In the form of rent from our tenants. And we use a portion of that rent to pay back the bank. So you, the real estate investor, you weren't paying back that loan. Your tenants are every single month, that balance that you owe the bank is decreasing because you're paying that back with the rent from the tenants. And eventually over time, that balance is going to be gone. And it's going to be paid completely off by the tenants. If you compare real estate to borrowing money to purchase a car, for example, a car is a depreciating asset. As soon as you drive the car off the lot, it goes down in value. And the car also isn't generating any income. Or generating any cashflow. So this is what we refer to as a bad debt because you're borrowing money to buy something that is one losing value and two, not generating any income. Loan pay down is another factor that is increasing your equity as the property owner. Now to revisit equity quickly, it is the market value of the property minus any outstanding debt. So your equity is increasing in two ways. First, when the property value is increasing through appreciation, that increases your equity, but also second, when your outstanding debt is decreasing, that is also increasing your equity. And the beautiful thing about real estate is that these two things are happening likely at the same time. Last but not least, the fourth way that real estate is making you money is through tax benefits. It's not about how much you make. It's about how much you keep and real estate is a powerful vehicle to ensure that you keep. More of the income that you're making. Now, quick disclaimer, I am not a CPA. I have my undergraduate degree in accounting, but I did not take the CPA exam and this is not tax advice. So don't sue me. Jokes aside, when the wealthy say they do not pay taxes, it's most likely because they're leveraging. Their businesses and their real estate. Now, how are they able to do that? The first thing to understand about the tax code is the U S government is incentivizing the behavior that it wants to see. Now, let me elaborate on that. When people start businesses, they are stimulating the economy by creating jobs. And in return, the government is rewarding that. With tax breaks, when people become real estate investors, they are creating housing in a market that we have a housing shortage and that is desperately needed. And so the government rewards that with tax incentives in the tax game, there are winners and there are losers. If the businesses and the real estate investors are the winners, then the losers are the w two employees who have to pay an exorbitant amount of income taxes to the U S government. The wealthy realize this. So they're very strategic about. Building businesses and investing in real estate to shelter more of their income from the U S government. And instead of getting mad and complaining that, Hey, this is not fair. You and I should do the same thing without getting too in the weeds, taking advantage of some of the tax benefits of real estate investing, like depreciation or writing off mortgage interest or leveraging 1031 exchanges means that you get to keep. More of the money that you make in real estate, which means more money in your pocket, more money to invest in more real estate. And on your journey to financial freedom, this can make all the difference. So even though taxes are super boring, if you're very serious about building generational wealth and achieving financial freedom, you need to level up your understanding of the tax game and make moves. Like the wealthy do there. You guys have it. The four ways that real estate makes you rich cashflow appreciation, loan pay down and tax benefits done correctly. A simple strategy like buying one rental property every year for the next 10 years can yield tremendous results. Over the longterm and bring you closer to financial freedom. I hope you guys enjoyed that video. It is now nighttime. It took me a lot longer to record that than I thought, but if you hit that like and subscribe button, it would all be worth it. In the next video, we're talking about real estate versus stocks. So make sure to stay tuned for that one. If you're interested in that investment head to head battle. Also, I have a lot of free investing tools and resources that will be helpful on your real estate investing journey. So you can check those out in the link in the description below. And I will see you guys for the next video. Peace.