REASON #2 - Demand
People always need a place to live. Shelter is one of the basic requirements of man. This fact alone, gives multifamily residential properties an advantage over other types of real estate investments. You can rest assured knowing that there will always be a demand for residential housing whether the market is going up or down.
Because of this, there has always been a traditionally demand for rental housing. Let's look at a number of factors that will cause demand to soar even higher in the next decade to come.
ECHO BOOMERS (children of Baby Boomers)
Echo boomers are a group of individuals comprising of those born between 1982 and 1995. It is estimated that there are around 80 million echo boomers, currently living in the United States. This makes up the largest demographic group in the United States since the "Baby Boomers" of the 1960's. As a group they comprise over one-third of the total U.S. population. The media has labeled them echo boomers because they are the offspring, the "echo" of the last great population surge in America, the baby boomers.
The reason echo boomers are so significant, is that it is estimated that over the next decade approximately 4 million of them will become adults each year. According to a study generated by Harvard University Joint Center for Housing Studies, 80 percent of all households who residents are under the age of twenty-five are renters, and 65 percent of those with residents ages twenty-five to twenty-nine are renters. That's a lot of renters!
Until their children (Eco boomers), came along, Baby Boomers (1960's) were by far the largest demographics in American history, generally estimated to be around 78 million. Baby Boomers are are generally considered to be those having been born between the years 1940's and 1960's. The first individuals born to this era are just now beginning to reach retirement age.
According to the same Harvard study (we quoted for the Echo Boomers), a large portion of Baby Boomer aged sixty-five and older are renters. It is estimated, that there are currently 4.1 million households aged sixty-five or older, where an individual rents in the United States. This number will grow exponentially in the coming years as more and more of these (78 million) Baby Boomers begin to retire.
The National Association of Relators, wrote an interesting article. - where is said, 19 percent of all Baby Boomers are renters and 37 percent of them, admit that they will have difficulty making ends meet. Many of these households rely on dual incomes. It is inevitable that the financial pressures of retirement (unexpected medical costs, or if a mate dies) will force some of these households to rent after retirement.
Retiring Baby Boomers will thus be an important factor in the rental market in the years to come. For this reason, I believe one of the best investments to make at this time, are multi-family residentual communities.
If we put Baby Boomers with Eco Boomers, this represents 158 million households - comprising of two-thirds of the entire U.S. population - who will potentially be renting in the years to come. This will put a huge upward pressure on occupancy and rental rates. Which means, we could be seeing the beginning of the golden age as it relates to investment housing. When you are looking at numbers like this, it may seem like pay day everyday. And as if that weren't enough, there is another demographic group that we have not even considered yet as to potential renters: Immigrants.
REASON #3 - Immigrants
According to a recent Harvard study, immigrant populations were responsible for 45 percent of all rental growth between the years of 1994 and 2004. For this reason, immigrants have become a major force in the investment market.
Since the 1960's, the number of immigrants has continually grown in the United States - with each decade. In the 1900's alone, 10 million immigrants entered the United States, and those are just the legal ones. The Hispanics population, account for nearly half of the immigrant number. As of 2006, the United States has continued to accept more immigrants into its borders, than the entire world combined. Between 1990 and 2000 the immigrant population in the United States rose by 57.4 percent according to the U.S. Census. And immigration is expected to continue growing in the next decade.
According to the U.S. Census, only 34.9 percent of non-citizen residents are homeowners. The remaining 65 percent of the immigrant households - are renters. What this means, is that by the year 2010 - an estimated 26.3 million immigrants will be paying rent somewhere. Add this to the 52 million echo boomers, and 14.8 million baby boomers who are considered renters, and by doing so - you now have an estimated 93 million renters will be added to the market over the coming years.
Numbers like that simply can't be beat in any other sector of the real estate market. For this reason, immigrants is a valuable consideration as reason number three.
REASON #1 - Cash Flow
Cash flow is a vital element of the power of real estate investments. If you don't have a property management company on your investment team - get one now. Properties that are managed well are properties that realize net operating income growth every year. This takes expertise and a lot of time. Unless you are an expert in property management, there is no way you can get a property to perform unless you have had the education and training to do this. This starts by having a sound management plan, as to how you are going to increase your net operating income. The basic principle behind every sound property manager, should be the reduction of expenses and the increase to income. Sounds simple, but it takes real expertise to do this.
Like a lot of real estate investments, cash flow provides you with passive income that can be tax-free after depreciation. The distinct advantage that multi-family real estate has over other types of real estate, for example commercial is that cash flow, can be manipulated quickly.
In commercial real estate leases can be for many years. If I'm the landlord, that is a scary proposition. While the security of a long-term lease is nice, it doesn't allow you to take advantage of fluctuations in the market. Meaning, as rent levels go up you can adjust your rents accordingly. Thus minimizing any loss you may receive to being locked into long-term leases. Let me explain: Suppose you own a piece of commercial office space and sign a lease with a resident at the going rate of $4,000. per month for three years. One year later, demand increases and the going rate is now $4,500. per month. Because you have signed a long-term lease, you cannot take advantage of this upswing. Essentially you would be leaving at a minimum $500. per month on the table every year. That works out to $12,000. in lost income from just one commercial space.
In multifamily investments leases tend to last normally six to twelve months. This allows for constant adjustment of rents - up or down, if necessary - to maximize market values. Additionally, multi-family apartment buildings tend to have more density than commercial buildings. Density basically means more individual residents on shorter term leases. This provides you with more flexibility to adjust to ever changing markets. On the flip side, you can require longer term leases - in a market that is having a downturn, as this can help to minimize your loses.
There is an easy way to calculate the value of your investment. Take the net operating income from your investment property and subtract your operating expenses. This will give you what is called the Net Operating Income. From Net Operating Income, you subtract our mortgage payment, and this brings you to cash flow.
Divided your net operating income (NOI) by the going capitalization rate. If you don't know what the going cap rate is, contact a real estate professional (broker - such as myself) to assist you with this. Capitalization rates are determined by evaluating recent sales statistics of similar properties in a given market area. Your broker will be a valuable tool in determining your market's capitalization rate.
If you have a property with an annual $100,000.00 NOI in a market where the capitalization rate is 6 percent, then the value of the property would be $1.66 million. Your equation would look like this:
NOI ($100,000.00 (divided by) Capitalization Rate (6%) = Asset Value ($1.66 million)
If you want to dramatically increase the value of your investment, then you do this by increasing the Net Operating Income. If you increase value, then this means, you can quickly then realize these benefits by refinancing your property and reinvesting the equity into other multifamily investments.
REASON #9 - Real Estate is a Tangible Physical Good & Asset
What does that mean? Real estate is not some cerebral investment that is traded by the click of a button on an online brokerage. With real estate, you can hop into your car, drive to your property, walk around, inspect the buildings, and question your staff. Because of this, is is not subject to the volatility of stocks and bonds, or other investments.
With other types of investments, change can happen fast. We all saw this in the 2008 banking melt-down, when the majority of American's lost their investments on paper, right before their very eyes. When it comes to stocks, you are basically at the mercy of the company's public relations department. Which means, you have to just sit back and wait for them to publish their earnings. If the company had a poor quarter, then your stock will typically drop fast with little or no warning. All you can do at that point, is react, but this usually doesn't happen without losing a substantial sum first.
With real estate, it's different. While real estate can still have it's ups and downs, real estate for the most part is slower to react to sudden changes. If you are paying attention and know what to look for, you can see market trends way before they happen, and this allows you time to react or formulate a plan to either cut-back, sell or exchange. Maximizing your return on investment, or your cash-on-cash return, is essentially the key.
Additionally, real estate is not as liquid as other investments. That means that it is not a quick buy-and-sell transaction like stock. When you sell liquid investments, you earn cash quickly, therefore you are taxed at a very high capital gains rate. With real estate, gains are realized at a much slower rate, which makes your tax exposure significantly less, compared to other investments.
Reason #8 - Hedge Against Inflation
For most people, they may feel that the most practical thing to do, is take your money and put it into a savings bond or bank account that yields 2 to 3 percent per year. The main argument here is that this type of investing, is what most people consider "safe", or at least safer than other types of investments. The problem with this type of thinking, is that you don't make any money. This is because of one word, inflation.
Inflation is the price of goods on things like cars, food, clothes, and so forth measured against a standard of ability to purchase those goods. For example, the price of gas has basically risen fairly heavy recently. Of course, this depends on where you live, but for most people there has been at least a $2 to $3 increase in just over one year. Really when you think about it, that's a 50 percent increase! Did your salary at work increase by 50 percent? What this means, is you have less purchasing power when it comes to gas, than I did a year ago. This is because your dollar doesn't buy as much gas as it used to.
Now you may feel that using gas is a fairly extreme example, but it drives home an important point - that the price for consumer goods has consistently risen at a fairly consistent rate. To put it simply, you are actually losing your wealth because inflation is higher than your returns. Any gain in interest is wiped out by the rising cost of living. You are not becoming wealthier, you are just maintaining.
Another important fact to consider is that only time inflation was negative over the last century was during the Great Depression. If you factor that out, inflation has historically risen by 4.1 percent per year. Which means, if you have your money in a savings account earning 3% interest per year, you are actually losing money. Because the cost of good is growing faster than the value of your money.
The beauty of real estate is that it is a tangible asset (rent is a tangible asset, much like gas, food, and clothing). What does that mean? It means that your tangible goods (i.e rent), will rise at the rate of inflation or much higher, just like other tangible consumer goods. Historically real estate has risen at 6 percent per year - a full 2 to 3 percent higher than inflation. And that is just appreciation. That doesn't take into consideration the cash flow you generated from a real estate investment, nor the tax advantages, depreciation, and tax-deductible mortgage interest. So, do you still think that real estate is an "unsafe" investment?
Often times, even real estate investments that perform poorly will still perform better than what many people consider a "safe" investment (i.e. bonds, stocks or mutual funds).
REASON #7 - Asset Protection
There are a number of ways to legally protect your real estate investment that cannot be utilized with other standard investments. For instance, with stocks and bonds, if the company that you have invested with, has a bad year, then you are simply out of luck.
Property insurance is often a big cost in real estate investments, but is often covered by your property's income. It is essentially free to you, since it is often considered an operational cost of the property, and therefore can be a tax-deductible expense depending on where you live.
Insurance is one of life's necessities that go beyond the realm of real estate investing. Most people don't think about the fact, that real estate is one of the few investments that you can insure. When you invest in real estate (and you have insurance), you have the peace of mind, knowing that if your real investment is destroyed, you are covered for any losses. Given the fact that you carry the proper amount of insurance, you should be able to claim your losses for the actual value of the asset before the loss, and during the loss.
Another legal advantage of real estate investing, is that you can take ownership of this investment in the name of an LLC, or a legal corporation (such as an IBC - International Business Corporation). Holding ownership to your real estate asset in a legal corporation, allows you to protect your personal wealth by individualizing and protecting your asset as well. If for any reason, you were to be sued, your other personal assets (such as,) your house, bank accounts, and investments, would be protected because they wouldn't be property of your legal corporation.
Each and every property that you buy should be placed in its own IBC or individual corporation. That is one of the greatest ways to protect your wealth. Imagine you own multiple investment properties and one of your residents fell in the shower and became injured. If all of your properties were under a single entity (the same legal corporation), then that resident would have the legal right to pursue damages based on the entire asset value of all your investments in that entity. If, however, each property was its own legal entity, that resident should only be able to seek damages from that entity. Your other holdings would not be affected.
In addition to the legal protections that an IBC (International Business Corporation), provides, there are also many other distinct advantages, that may be available to you. Since each person has a unique circumstance, I cannot cover all scenarios in this short blog insert. I therefore recommend contacting me directly for a one-on-one personal consultation. I will be happy to assist you in becoming more knowledgeable about how to protect your assets, and what advantages may be available to you.
One of the ways to find a great investment, is to research. This can be done in a number of ways. First, find yourself a top real estate agent. One that has a dynamic reputation, who excels in their knowledge on their market area and has a proven tract record.
LEVEL ONE RESEARCH (Gathering Your Information): Research can begin in a number of ways. As with any endeavor, finding the right people is your key to success. Start by researching who is top in their game. Chances are, a top real estate agent, didn't get there with only a passive knowledge of their subject. Spend some time finding that top agent, and this will open up many doors for you as to finding the right property. A top real estate agent, can help educate you on what you can expect for certain price ranges, they can help you with investment counseling and income rental projections. Understand what you want, and where best to find it. This is the time to gather as much data as you possibly can about what you are looking for. This may be the time to put together a list of things you are looking for in your investment. It is a time to study your market areas, so you understand where the best investment deals can be found. Then an experience real estate agent can help guide you in the right direction. Gather your data, know what you want, find the right real estate agent.
LEVEL TWO RESEARCH (Selecting Your Team of Experts): This is the time when you can hit the ground running. You may travel to your proposed market destination and meet with your team area experts. This is the time where the research you have done, goes into action. This is when you look at the financial sheets, review the property data, and tour various properties.
LEVEL THREE RESEARCH (Making Your Decision): Once you have gathered all your information, and seen the market that you are interested in - you then to start narrowing down which properties meet your investment criteria. This is when an experienced real estate agent can (be worth their weight in gold), they can help point out positives and negatives about various investment properties. Thus helping you to avoid common pitfalls that many others make. Often this real estate expert will have information that will help you, which often compliments your own research data. They may have additional things to consider, points to share, dangers to avoid, before you ultimately make your final decision. A second pair of experienced eyes is always a good idea before signing on the dotted line.
REASON #6 - Refinance
Another advantage of real estate over other investments is the ability to withdraw cash from a property by refinancing. This, too, in most cases is a tax-free transaction. When you refinance a property, you are restructuring your existing mortgage debt - based on the added value your property will receive by adding amenities, improvements and/or services.
In almost every instance, it may be best to refinance a property, rather than to sell it. Let's discuss why.
Take for example a senior housing property, purchased for $9 million (with bank financing at $7.2 million). In reviewing the property prior to purchase, it was noted that by adding a few premium amenities to the first floor, this would create a higher occupancy level for the entire property. One such example of a premium amenity, was adding a 26-passenger shuttle bus, (for in house residents), to use coming and going to various popular destinations. In the first year alone, this improvement increased the value of the property by $910,000.00.
By adding a few of these premium base amenities, this in turn increased occupancy. When you increase occupancy, this increases cash flow. When you increase cash flow, you increase returns for investors. But where do you get the money to accomplish these improvements? From refinancing your investment and leveraging.
Within five years, this property almost doubled in value. The property is now more in a position to cover the higher mortgage payment, and best of all, the money from the refinancing is typically all tax-free.
So rather than perhaps selling your investment, refinancing and upgrading your property may be the wiser course to take. This provides you with a better competitive edge, and will ultimately result in a higher property value, increased occupancy levels, and cash flow.
REASON #5 - Depreciation
Depending on the country where you live, you may be able to take advantage of certain tax depreciation deductions, when it comes to buying real estate. This tax deduction, is usually an annual allowance for wear and tear, deterioration, or obsolescence of your real estate investment.
For the purposes of real estate investments, it's a non-operational expense that can be used to your advantage come tax time. In the United States, your depreciation is calculated as an expense, based on tables the government provides, showing you the number of years that you can depreciate your property. The depreciable years are vastly different depending on the asset. For instance, residential investment real estate is 27.5 years, while commercial real estate is 39 years. The basic equation for figuring depreciation is:
Total Asset Value (less) Land Value (divided by) Depreciable Years = Annual Depreciations
Let's discuss an example, to better illustrate this concept. Let's say a building (with land) has a value of $19.7 million. In order to estimate your depreciation, we have to first subtract the value of the land, since most governments do not consider land to be a depreciable asset. Depreciation only accounts for the building on the land, since they will lose value as they age. Let's say the estimated value of the land is $3 million. Now let's calculate your yearly depreciation based on the a government table of 27.5 years.
$19,700.00 (less) $3,000,000. (divided by) 27.5 years = $607,273
Now why is depreciation important. Remember depreciation is treated as a non-operational expense. Therefore you can take that annual depreciation of $607,273 per year, and off-set your cash flow. This is a tremendous advantage come tax time. Review the following to better grasp the concept.
$19,700,000.00 - Purchase Price
$ 3,000,000.00 - Land Value
$16,700,000.00 = Total Depreciable Value
$607,273.00 - Annual Depreciation
Now look at how that applies to a simplified property financial
$2,200,000.00 - Rental Income
$ 500,000.00 - Other Income
$2,700.000.00 - Total Income
$1,500,000.00 - Operating Expenses
$1,200,000.00 - Net Operating Income
$ 900,000.00 - Debt Service
$ 300,000.00 - Cash Flow
$ (607,273.00) - Depreciation
$ (307,273.00) - Net Income After Depreciation
Before depreciation, you would be required to pay taxes on the $300,000.00 in cash flow. Depending on your tax rate, that can be a chunk of change. But if you apply your annual depreciation to be subtracted from your cash flow, you basically end up with a $300,000 loss, instead of a $300,000. gain. This means, you don't have to pay taxes.
Money tends to produce more money - when invested right. With this example scenario, the property producing $300,000.00 per year in tax free cash flow. You are then able to use this money to leverage more investments. Each time we take advantage of our leveraged return on our money and our tax free cash flow, this allows us to steadily compound our investment potential, increasing our net worth.
Depreciation may not be applicable in all countries when trying to invest, but for those countries who do allow it - it is a serious consideration when purchasing real estate.
REASON #4 - Leverage, The Use of Other People's Money
Leverage is my favorite word, when it comes to discussing real estate investment. Leverage is about the use of other people's money. The concept is simple and powerful.
The use of other people's money, is the concept of using money generated by someone or something else. While it is true that you can leverage stocks (to some extent), there is no other application of leverage which is more powerful than the leverage found in the real estate industry.
In real estate, leverage is based on the asset itself and how much you can get a bank to loan money on this asset - whether it be 80%, 90% or 100 percent, of the total asset value. Why do banks do this? Because they can repossess the physical asset itself should you default. When buying stocks, often you can only borrow up to 50 percent of the stocks value. Not to mention, you must purchase stocks through brokerages (not banks), at high interest rates. In other words, when you buy stocks, you are taking the risk. But when you buy real estate (with a loan), the bank is taking the risk.
What's more, buying stocks is considered far riskier (than real estate), because of the volatility of the stock market. If your portfolio takes a huge dip, you still have to pay the margin, but have no asset to fall back on. Buying on margin is an investment where you can actually stand to lose more money than you invested. Where real estate on the other hand, is a physical asset that you can fall back upon, and less volatility, which is why a bank will be your partner.
So how is it that an investment in real estate with a 6% percent rate of appreciation, can be a better investment than a stock yielding a 10 percent rate of appreciation? One word: leverage.
When you leverage an investment, you reap the benefits of the appreciation on the total asset value, while only having a small percentage of your own money in the deal.
In any investment, the goal is to have the highest cash-on-cash return, or return on investment (ROI) possible. ROI is the percentage return on your investment as compared to your invested dollars. In order to determine ROI, you divide the amount earned by the original investment.
ROI = Return on Investment (divided by) Original investment
Here's an example. Let's consider that $200,000.00 property we discussed earlier. Given the fact that after thirty years the property is now worth $1,083,6768 (based on a 6% annual appreciation rate), we take the value ($1,083,678.00), divide by our original investment ($40,000.00) to find our percentage ROI, divided by the number of years we held the investment.
INVEST IN REAL ESTATE
$1,083,678. (divided by) $40,000.00 = 2.709% (divided by) 30 years = 90.3% per year
In this example, our ROI would be 90 percent. Is that not unbelievable? And that doesn't even include the cash flow generated from the property or your tax breaks! Now let's compare that return on that $40,000. invested in real estate (w/ a 6 percent annual appreciation), compared to the $40,000. invested in stocks (w/ a 10 percent annual appreciation), for the same amount of time.
If you held on to your stock for the same thirty years, and it appreciated at 10 percent per year (instead of 6 percent) for thirty years, your $40,000. of stocks would be worth $634,524. That would mean your ROI would be:
INVEST IN STOCKS OR BONDS
$634,524 (divided by) $40,000. = 1,586 percent (divided by) 30 years = 52.8% percent per year
Don't get me wrong, 1,658 percent return on your money is an awesome return on your investment - but it isn't the best return on your money - when you compare it to the return yielded from purchasing real estate.
Do you not find it amazing, that a return on a stock that produces 10 percent per year is nearly 50 percent less than a return on real estate that produces 6 percent per year? Even then, we are not taking into consideration the cash flow or the tax advantages on real estate investing - which you do not get from purchasing stocks or bonds. This is the magic of leverage, and the power of real estate. If you do your homework, more times that not, you will find markets and purchase property, where the appreciation level is well above industry averages for a given area.