The Quick And Easy Math of Real Estate Investment | Nexus Property Management® Franchise

16 April 2024

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SHINING A LIGHT ON THE POWER OF RENTAL PROPERTY INCOME

If you’re interested in getting into real estate investment, congratulations! We can’t think of a better way to make your money work for you than investing in rental property. Doing your homework is a great way to start and this article will cover all the basics for you. Nexus Property Management® has been in the game for over a decade and we’ve worked with owners at every different stage of their investment journey. The one thing that…

To simplify, successful investing comes down to fully understanding the income potential of a property compared to the expenses and financing costs. 2023 was a perfect example of how rising expenses and financing costs can impact investment opportunities. Inflation coupled with low supply and high demand led to higher costs for materials and for maintenance servicepeople. With mortgage rates rising up to 8% from as low as 2% a couple years earlier, investors really had to look hard at whether or not there was enough income potential in rental properties to overcome these extra costs. Expectedly, the market came to a halt.

But you’re not here because the market is stuck…you’re here because you’re getting ready for the market’s cogs to start moving again, and we’re seeing plenty of signs that it is indeed warming up. So let’s turn our focus to the income side and the power of rental property ownership.

THE FINANCIAL BENEFITS OF RENTAL PROPERTY OWNERSHIP

There is great upside to investing in real estate and we can break the financial benefits of owning rental property into four major categories:

1. PRINCIPAL REDUCTION

As tempting as it is to think that the extra money you’ve got after covering your expenses (cash flow) is the major perk of owning rental property, it is not. The most significant expense anyone who receives financing will have is the principal on their mortgage. And here’s the beauty of it: once you’ve paid that downpayment and have your tenants in place, you technically don’t have to pay toward that principal ever again. Instead, your tenants will be paying toward your owning this property in full. To play that out with a real example: you purchased a three-family home for $325,000 and you needed to put $100,000 down to receive the loan. You owe $225,000 but that will be paid for by your rents. For the cost of $100,000 you’ll have an asset that is worth $325,000 when all is said and done. Your tenants will be buying you a house. You can’t beat that return on investment!!!

LEARN MORE: NEXUS NICK BUYS A RENTAL PROPERTY – A TYPICAL JOURNEY OF A NEW INVESTOR

2. CASH FLOW

Cash flow is the most immediate benefit of owning a rental property. After you’ve used your collected rents to pay off the property’s expenses, there should be some left over. This is the income the property has generated and it will be taxed as such…but it’s yours to use as you wish.

LEARN MORE: NEVER ACCEPT CASH PAYMENT FROM TENANTS!!!

3. INCOME TAX SAVINGS

Speaking of taxes, any expenses (including the interest on your mortgage) that go toward your rental property can and should be claimed against your income when you file your taxes. If you spent $6,000 to repaint and add new stainless steel appliances to your kitchens, those are business expenses that can be written off. Additionally, the cash flow and principal reduction mentioned above are sources of income and are taxed as such, but rental property ownership allows for consideration of depreciation as a tax shelter.

LEARN MORE: HOW DOES REAL ESTATE DEPRECIATION WORK?

4. APPRECIATION

We like to remind rental property owners that real estate investment is a business that leads to passive income. Appreciation, the fourth income-related benefit, is the most passive of them all. Appreciation simply refers to the increase in your property’s value. You very easily could’ve bought a home ten years ago for $200,000 that today is valued at over $400,000. That $200,000 difference is real and it’s yours if you were to sell at that price.

LEARN MORE: NEVER ACCEPT CASH PAYMENT FROM TENANTS!!!

5. DEPRECIATION

As much as you ‘appreciate’ your property, don’t forget you have to ‘depreciate’ it as well. One of the lesser known tax deductions is the yearly depreciation of the property assessment (not the land) over a 27.5 year period. So, if your house is assessed at $100,000 and land is assessed at $50,000 you can depreciate (or deduct) $3,636.36 for the next 27.5 years. This deduction will reduce your taxable income! It’s not without strings however. Depreciation expense taken by a real estate investor is recaptured when the property is sold. Depreciation recapture is taxed at an investor’s ordinary income tax rate, up to a maximum of 25%. Remaining profits from the sale of a rental property are taxed at the capital gains tax rate of 0%, 15%, or 20%. This is where the 1031 Exchange comes into play so you can take those proceeds and kick your tax burden down the road for more time.

LEARN MORE: WHAT IS A 1031 EXCHANGE?

WHAT SIZE OR TYPE OF RENTAL IS BEST?

The more rental units you have, the more insulated you’ll be from losses, or negative income. Nexus works with dozens of investors who own single family homes and rent them out. This could be risky if you have just one home, because an eviction, major maintenance issue (think boiler replacement), or vacancy means you’re on the hook for 100% of the expenses, but if you’ve got five single-family homes, you’re covering yourself with the income from the other units.

Most typically that same principle plays out in multi-family homes. A duplex is OK but typically leads to limited cash flow. A three-family, which is most common up in New England, provides more cushion. A four-family (or more) is best in that it provides added insulation from losses and maximizes cash flow as well…but they’re also more expensive and require greater downpayments.

LEARN MORE: THE SECRET ABOUT THE MOST SUCCESSFUL PROPERTY MANAGEMENT CLIENTS

THIS ALL SEEMS TOO GOOD TO BE TRUE…WHAT’S THE CATCH?

The catch is that it’s still investment, and all investment comes with risks. Markets can be stubborn and acting too rashly can have devastating consequences. Expenses can be difficult to predict and if a major issue arises before you’ve built your reserve back up you could find yourself in a tough spot. There are simply some things you can’t control. There are also plenty of things that go wrong that you can control if you have an experienced eye or hire a property manager to help maximize your returns and limit your exposure to risk .

LEARN MORE: THE SECRET ABOUT THE MOST SUCCESSFUL PROPERTY MANAGEMENT CLIENTS

CONCLUSIONS AND NEXT STEPS

Nexus Property Management® is a national franchise with five offices across the country. All of our owners are real estate investors themselves and the majority were Nexus clients prior to opening franchise offices of their own. If you’re interested in learning more about Nexus’ services, contact any of our teams across Arizona, Connecticut, Massachusetts, and Rhode Island.

LEARN MORE: THE 3 PROS AND CONS OF HIRING A PROPERTY MANAGEMENT COMPANY

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Mick Lefort is the General Manager of Nexus’ New Haven County Franchise Office and the Vice President of Operations for Nexus Property Management®, a National Property Management Franchise that manages all types of rental property from single family homes or condos to large apartment buildings and complexes.

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