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Real Estate Can Give You High Growth Rates at Low Risk

By Shane Flait

Republish: EasyPublish™ Published: 11Oct2009 Word count: 773 Viewed: 517 time(s) Get Free Content For Your Site

Buying residential housing offers the best investment for relatively little risk if done conservatively. Whether you buy home or a house to rent, tax laws, leverage, and demand help you to acquire and grow your real estate investment. This article shows you how.

Tax advantages on selling:

Investing your money directly in either your home or a house to rent out offers significant tax advantages. Both home ownership and residential property gains are subject to the low capital gains tax when sold.

And, for your own home, you can exclude a high amount of gain - $250,000 if single or $500,000 if married - when you sell. This often eliminates capital gain tax on it altogether.

Tax advantage on holding property:

Very few of us can buy a house with our own cash. We need a bank to help us buy it; and that's done with a mortgage - i.e. a loan from the bank.

We put a fraction of the house price down (for the seller) and have the bank pay him the balance. The balance is the principal mortgage loan amount which we pay back typically over 25 or 30 years in monthly payments.

Each monthly mortgage payment includes a portion for interest with the balance of the payment going toward paying off the principal of the loan. The principal payment portion eventually kills off (amortizes) the loan.

For a 25-year mortgage, early payments are mostly all for interest payments; ending payments are mostly all for principal. At about year 18, the interest and principal portions of each payment are equal. So it takes 10 years or more before you're reducing the principal you owe significantly.

Tax laws favor using mortgages since it allows you to deduct the interest portion of your mortgage payments from your income. This helps you 'hold' your property - whether you're a homeowner or buying the house for its rental income.

Homeowners deduct the interest portion of their annual mortgage payments on their Schedule A (itemized deductions) of their 1040 Income tax form. These sizeable deductions reduce the amount of income tax that homeowner's have to pay - and so help them to be homeowners rather than renters. Remember, too, that if they didn't own their home, people would have to pay rent anyway.

Rental income owners claim their rental income on a Schedule E (Rentals) but they also get to deduct not only their annual mortgage payment interest, but also other annual costs of owning the rental property such as maintenance expenses and an annual depreciation amount. These deductions can help reduce taxes paid not only on the rental income itself, but sometimes on the investors own personal taxes on his form 1040.

Leverage:

Because most housing is bought with a mortgage, your investment in the house is originally the amount you put down - called the equity. Your equity is always the value of the house less the mortgage amount you owe. Since the bank's mortgage claim is fixed, any increase in the value of the house directly increases your equity.

Leverage makes your equity growth rate grow faster than the house's value - and that can mean a high investment rate for your investment. As long as you put enough down for your initial investment and maintain your income, you should be able to weather most market downturns.

As an example of equity growth, consider you put 20% down for a $100,000 house - which gives you $20,000 in house equity and an $80,000 mortgage. If house prices rise just 4% over the next year, your $100,000 house become $104,000. Though you still owe about $80,000 on the mortgage your equity is now $24,000. That's a 20% equity growth rate - a high investment!

Demand:

People need to live someplace and the number of people is always increasing. This pretty much keeps housing prices going up - generally about 4 or 5% per year over the long run.

But, because buyers most qualify for mortgages, interest rates affect not only the numbers of buyers but the house price they can bid for. Lowering interest rates allow more people to qualify for mortgages - and to bid higher on a house. This causes temporary upward pressure on housing prices. The reverse occurs with rising interest rates. But these effects are shorter term and put peaks and dips on the relentless rise in prices.

If you put enough down so as not to be too exposed to holding costs and can maintain your income for your own house, or rent income for your rental, you should be able to hold out through various economic downturns. Then your responsible level of leverage will help you grow your wealth faster than most other forms of investment.

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