Every investor grapples with the same question: “What’s the safest, highest-return and most tax-advantaged investment vehicle?”
It won’t take much research before you’ll find the profitable investment niche of income-generating properties. The benefits of this investment avenue are so dramatic that it’ll be apparent how real estate generates so much wealth.
Why Invest In Income-Generating Properties
We’ll get right to it: Rental properties can make you money and save you money at the same time. Not many other investments can do that. Among other things, income property investment is an extremely flexible wealth creation strategy that can give you much more control over the outcome compared to traditional investments such as stocks, bonds and mutual funds.
You’ve heard all about passive income. It’s a buzzword that hasn’t lost its resonance due to the established benefits of generating income without doing all the work or limiting yourself to the value you can create as an individual.
In addition to the rental income generated, the value is likely to appreciate — if you pick the right market. This increase will occur even if you don’t make any effort to improve the property or optimize its operation. Rental property investing represents tolerable levels of risk, given the stable returns and considerable tax benefits it offers.
Besides, rental property management is a relatively simple business where initial due diligence and effective financial/operational management yields investments that are more stable than alternatives. Not only is it low risk, but you can also get ahead with deductions. Income property investments offer deductions for interest, depreciation, repairs and all the typical expenses associated with running a business. The Tax Cuts and Jobs Act of 2017 (TCJA) additionally gives rental property owners a 20% deduction on income.
Another tax deduction opportunity created by the TCJA is the opportunity zones program. If you choose to invest in rental properties in these designated emerging communities through a qualified opportunity fund (QOF), you can cut or eliminate your capital gains tax liability depending on the length of your investment and contribute to the growth of struggling neighborhoods. This is a more flexible alternative to 1031 exchange.
Types Of Value
Two of the primary types of property value are the actual fair market value (FMV) of the property and the value calculated based on the income it produces through rent or other means of recurring revenue.
For income properties, fair market value is typically determined by capitalizing the net operating income (NOI) using a rate based on the risk and return associated with the project. For new construction or existing special-use properties, value is calculated by looking at the construction cost for a functional replacement or reproduction of the structure.
The upside of value based on income is that it allows us more control over how much our properties are worth. You don’t have to wait for external economic factors to improve value: You can cut expenses, improve the condition, raise rents, decrease vacancy, increase energy efficiency and find additional revenue streams (paid amenities, vending, etc.) to increase NOI and value.
Selecting A Property Class
The benefits of operating income-generating properties span all classes of real estate. The choice of which property class to pursue — single- or multifamily, retail, mixed-use, etc. — should be based on your background in real estate, preferences, management team experience and investment goals.
Single-family properties provide one source of income, which can potentially mean putting all your risk in one unit. If you experience an extended vacancy, it’s harder to absorb the loss. Five-plus unit properties reduce the risk of negative cash flow.
Multifamily rental properties, especially those greater than four units, offer more opportunities than single-family to enhance the value and position yourself for a favorable exit. Incidentally, capital is readily available for acquisitions, and cash-flowing opportunities exist in many markets.
There is predictable growth in multifamily as these properties have higher tenant demand and turnover. More units provide expanded opportunities to maximize the value of each door by bringing rent up to market value with each new lease.
Endless opportunity to generate direct revenue also exists in commercial income properties, although the barriers to entry are somewhat higher and the risk greater. The commercial market is typically more volatile than its residential counterpart and necessitates a qualified team and expert planning to execute successful transactions and investments.
Selecting A Suitable Geographic Market And Analyzing Opportunities
Location is usually the most crucial factor in the success of your income property investments. Regardless of where you live, you can invest in hot real estate markets across the country through local investment companies. The formula for a growth market and stable investment environment is straightforward: strong population growth, job availability, industry growth, rising incomes and affordable housing.
Information on hot markets such as California, Massachusetts, New York, Florida, Arizona, Texas and other headline markets is readily available online, and numerous real estate professionals and investment advisors are available in every region to assist with market research and analyzing investment opportunities.
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