Real estate

4 Low Risk Ways of Starting Your Real Estate Empire

Real estate investing can be lucrative over the long haul, but most people never even get started except for owning their own home. How can you get starting without taking upon too much risk?

Don’t sell your home: It is very common for individuals to purchase their first home with little money down and then sell and move after a handful of years. Usually, there is some equity in the home, which is used as a down payment on a larger home. Aside from a large percentage of your equity being eaten up by selling costs, you now have another 30 year mortgage, most of the time. However, another option is to save up the funds for a down payment on a larger home and then rent out your original home. You still need to prepare the calculations to see if this makes economic sense, and if so, then now you are officially a landlord.

Buy the building: This option is for business owners only. Over time, if your business is growing profitably, then owning a building instead of renting could be a good option for you. There are several advantages to purchasing a building and renting to your business. First, if you occupy a majority of the building then you may be eligible for SBA funding, which generally requires a much lower down payment then traditional financing. Additionally, you know the tenant really well.

Partner up: I’m not a huge fan of partners for various reasons, however, you may have a family member or friend that you can partner with to combine resources that you would not have if purchasing a rental property alone.

Look farther away: The real estate market in North Jersey is very expensive compared to other parts of the State and the country in general. If you look a little farther away, then you may be able to find a real estate property for much less, and quite possibly a higher ratio of rental income received versus the price paid. This will make it easier to come up with a down payment.

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Is Your House Really Considered an Asset or Just a Place to Live?

Is your house an asset? Some would say yes, and I am sure that some would say it’s actually a liability. Here are different ways of thinking about your house.

Asset: Hopefully your house will appreciate in value over time, but this is not always the case. Because of the often high amount of leverage that most people take on when buying a house, the increase in value can often be multiplied. If it goes down in value and you are underwater, then your asset turns into a nightmare.

Even if your house does appreciate in value it usually does not make much of a difference. This is because most people end up selling their first house and using the proceeds, if any after considering all of the costs of selling a house, to purchase a larger house. Any equity is then “locked up” in their new house again.

No income generation: Unfortunately, your house does not generate income, unless you own a multi-family property, which is not a bad idea, but shunned by most. As a side note, a good strategy is to purchase and live in a multi-family house as your first home, stay for a number of years, move to a new home, and then rent out your unit.

Place to live: Economically, over the long-term owning a home is much better than renting, although life does seem much simpler when renting.  If you think of your home as a place to live vs. an asset than your perspective will change, including funds spent on  improvements. A cost benefit should be considered when making improvements, but know that improvements to your home are not usually the best investment.

Using it as an asset: If your home appreciates in value and your mortgage balance has steadily increased then you have the opportunity to tap into the equity of your home. Just make sure to use this equity wisely as you don’t want to find yourself unable to pay your equity loans and then end up in financial turmoil. Investments considered should be high return, low risk, which they should always be.

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What is all the Hype About Generating Passive Income? Here are Four Examples

I’m sure that you have seen YouTube commercials about generating passive income while lounging in a pool with your collection of high-end sports cars collecting dust in your oversized garage. Is this really practical and can you really generate massive amounts of passive income? The answer is yes and no . . .

Passive income defined: Passive income is any income that is derived from sources that you do not actively participate in to generate that income. Examples can include rental real estate, businesses that you do not materially participate, and royalties.

Can you really do it?: Yes, you can do it, which is the simple answer. However, it is much more difficult than the commercials let in on. Here are several ways to generate passive income starting from the least amount of capital needed to the most:

Side business: Start a business on the side while you are either working as an employee or if you already have a business. In order to make your endeavor take as little time as possible, then your need to focus on a either a product or information based business, while skipping a service-based business. The reason for not choosing a service business is because it will most likely require much more of your time.

Existing business: No matter which business you are in, you can make your business less and less dependent upon you so that you are not required to materially participate in the day to day activities. However, this can take at least several years or more to make this happen, and you have to make sure that your sales can support the additional expenses. The approach must be methodical whereas each aspect of your responsibilities is either transferred to employees or outsourced. It is easier to do this if you have a business that is not very complex.

Real estate: Depending upon where you purchase real estate, this can take a lot of capital. However, if you choose a rental property wisely and continue to build your portfolio, then eventually your rental income can substitute your regular income over many years. A good place to start is to either purchase a building for your existing business or to rent your home if you plan on moving.

Investor/lender: Once you have a sizable amount of cash, then you can and should look for privately held businesses to provide capital for. This can be in the form of equity or debt. If you are very selective then you can build a great portfolio over time with returns that are much higher than traditional investments, although the risk will usually be much higher.

There you have it now go for it!

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So You Want to Flip Homes?

Buy a house, put in a few improvements, and then sell it for a much higher price. Do it again and again. It sounds so simple, but here are a few pointers to keep in mind if you want to succeed with house flipping:

Experience: If your experience in real estate is performing repairs on your home during weekends, then you do not have the required experience. Ideally, you should have experience in both residential construction and real estate sales.  Experience as a general contractor will help you to determine the amount of time and costs to improve a potential flip, while experience in real estate sales will help you to locate a property, determine the market characteristics, and eventually sell the property.  Both are extremely important because you want to maximize your profit by investing your time and money in the right house and the smartest improvements. If you do not have this experience then you need to spend the time to learn as much as possible before purchasing a flip to minimize costly errors.

Know your costs and potential selling price: Before purchasing a property you need to estimate your cost of purchasing the property, the necessary improvements, and carrying costs such as real estate taxes, loan payments, utilities, and insurance. Just as important is the estimated selling price. If you underestimate your costs, overestimate the selling price, or underestimate the time to improve and sell the property, then your chance of profit will be greatly decreased. The formula is simple, but not always easy to accomplish; profit = the selling price minus all costs. With this in mind you want to make sure that you leave enough wiggle room to make a profit in case your estimates are off.

Capital: If you don’t have the necessary capital to purchase a fixer upper, make improvements, and pay the carrying costs, then you need to either obtain a loan or partner with someone who has the necessary capital. Make sure that you have a cushion just in case your estimates are wrong.

Time and opportunity cost: Let’s say that you are a contractor and are looking to flip a house. Make sure that you estimate that you will make more money on the time spent with your flip than during your regular construction activities. The same goes for anyone else trying to invest their time and money in a flip.

Start small: If just starting out then make sure that your first slip does not have the potential to decapitate you financially. Just think back to what happened to many house flippers about a decade ago.

Taxes: Most likely your profit will be taxed at ordinary income tax rates and possibly self-employment taxes vs. long-term capital gains rates. This is due to the fact that you are usually considered to be a dealer with the intent to buy, improve, and sell a home in a short time frame.

Alternatives: An alternative and close cousin to house flipping is to rehab a rental property, rent it out, and hold it for the long term. It is not as exciting as house flipping, but it can be very worthwhile, while also carrying less risk.

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Don’t Sell Your House

Usually your first house is a “starter” home that you purchased because it fit into your budget at the time. A few years later you then sell your house, move up to a bigger home, and may even repeat this process several more times. But what if you didn’t sell your home and rented it out instead? Let’s look at the pros and cons of doing so:

Pros:

Easier Way to Have an Investment Property: If you were to purchase an investment property then you generally need a much larger down payment of say 20% – 30% compared to a mortgage for a home, which you may not have available. Additionally, the interest rate and payment terms are generally less favorable than a residential mortgage. Since you already purchased your existing home as your residence, you already have financing in place, which is avoids this issue.

Transaction Costs: Look at any settlement statement and you will see that the transaction costs greatly reduce the proceeds after selling your home. By renting out your home you will have avoided these costs.

Appreciation and Rental Income: If prices in your neighborhood are rising and there continues to be strong demand for housing then most likely your house will appreciate and so will the rent that you can charge. A rental property can also provide diversification to the stock market.

Cons:

No Down Payment for New Home: Homeowners usually use the equity from selling their home to purchase another home, but if you do not sell your home then you will have to either save up for a down payment or access your equity through a loan.

Negative Cash Flow: If your cash flow will be negative for the foreseeable future, then it doesn’t make sense to rent out your home. You have to also be able to have the cash to cover expenses when your house is vacant.

Leverage and Debt: Debt is a double-edged sword (that can be another article). You want to make sure that you aren’t so leveraged that it puts a large strain on your finances, especially if/when bad things happen.

You Are Now a Landlord: Who wants to be a landlord and clean toilets? This is a very common argument, but the answer should always be never because who likes problems? You should make sure that you have reliable handymen, plumbers, etc., and screen your tenants as much as possible. However, you should like the fact that you have created a financial asset for your well-being.

Most homeowners never even consider renting out their home, but it can be a viable financial strategy depending upon your situation. Just make sure to run the numbers first.

Never Pay Taxes on Your Real Estate Investment

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Real estate can be a great investment, especially with all of the tax benefits. You can generally deduct interest, property taxes, repairs, and depreciation. Sometimes, a rental property may even generate a tax loss, while being cash-flow positive. But what happens when you sell your property?

If you sell your property as a loss, then you may be able to deduct the loss against your other income. Hopefully, you will have a gain when you sell your property, and you can reinvest the proceeds into another property. The flip side is that if you do have a gain, then you will end up paying Federal and possibly state income taxes.

There is a way out from not having to pay any taxes on the gain of your real estate transactions. It’s called a section 1031 exchange. A 1031 exchange allows you to postpone paying taxes on the gain if you reinvest the proceeds in a similar property.  You will not have to ever pay any taxes on the exchanged property unless you sell it outright.

For example, let’s say that you own a small multi-family rental property that you are looking to sell so that you can purchase another rental property. The final sales price of your rental property is $400,000, which represents a gain of $150,000. Between Federal and state taxes you may end up owing approximately $50,000, for example, on your sale. But, if you located a property and properly executed an exchange, then you will not owe any income taxes on the transaction until you sell your newer property.

It sounds simple, but you must adhere to several important rules to make it work. First, when you sell your original property you have 45 days to find a replacement property.   The identification must be in writing, signed by you and delivered to a person involved in the exchange like the seller of the replacement property or the qualified intermediary.  Next, the replacement property must be received no later than 180 days after the sale of the exchanged property or the due date (with extensions) of the income tax return for the tax year in which the relinquished property was sold, whichever is earlier. The replacement property received must be substantially the same as property identified within the 45-day limit described above.

Ultimately, you must work closely with your attorney, realtor, accountant, and a qualified intermediary for the outcome to be as successful as possible.

Also, 1031 exchanges are actually quite common with vehicles. Trading in your vehicle for another is considered an exchange as well, but the rules are more stringent, whereas cars are not like-kind to trucks.