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A real estate investor is someone who actively or passively invests in real estate. An active investor may buy a property, make repairs and/or improvements to the property, and sell it later for a profit. A passive investor might hire a firm to find and manage an investment property for him. Typically, investors choose real estate for several basic reasons: cash flow, appreciation, depreciation, tax benefits and leverage. A cash flow investor might opt to put 5% or 10% "down" when acquiring a property. In so doing the investor will likely obtain favorable financing terms, and a lower mortgage payment. This will often result in "positive monthly cashflow" which is crudely derived by subtracting the monthly debt service from the monthly rent. Appreciation occurs over time, generally, though an investor may "force the equity" in a property by making enhancements to it or the surrounding environment to enhance its value. In general, residential real estate is valued by the "comparable sales" method which estimates the value of a piece of proprty under the principle of substitution. The comparable sales method estimates property values by comparing a subject property to similar properties sold in similar locations within a recent period of time. Depreciation is one of the many benefits afforded to real estate investors. Though the property is actually increasing in value, the government allows owners to systematically depreciate the property over its projected useful life span. Depreciation is an allowable tax deduction. In addition to depreciation, an investor will usually claim the interest portion of his monthly mortgage payment as a tax deduction. Leverage is a powerful reason for investing in real estate. If an investor used 100% cash to acquire a house worth $100,000, and the house increased in value by $5,000 in one year, then the investor made a return of 5% (assuming no other costs in this case). Now let us assume the investor obtained 95% financing. In this case the investor would bring 5% to the closing table, and the bank would loan him the remaining $95,000 to acquire the property. Now, assuming the same $5,000 increase in value, it is clear that the investor's cash contribution of $5,000 has yielded an increase in equity of $5,000 in one year, a 100% return. Real estate investing has become quite popular in recent years due to booming property values and low interest rates. |
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