1. Appreciation
Appreciation is the increase in value of a property over time. There is myth in this field that all properties appreciate in value or that properties generally appreciate by 3%. First of all, appreciation is all relative to what your purchase price was. You may have purchased your property for $200,000 while your next door neighbor purchased their property for $75,000 after the real estate crash of 2008. One of you will have much higher appreciation than the other. It will be your next door neighbor. Also, there are some parts of the country such as Alabama and Indiana where appreciation in certain neighborhoods is nonexistent. Investors buy these old cheap properties for cash flow which will eventually get wiped away when they incur capital expenditures such as HVACs, roofs and other differed maintenance and repair.
Phoenix Metro is a great market to invest in. It is the largest growing population in the entire country with over 70,000 new migrants from around the country every year especially from California. After Covid-19, I expect this number to increase drastically. Many Phoenix residents may not be happy about the new migrants from California, New York and other states but it is a realty. Enjoy the 20-25 minute commutes across Phoenix Metro while they last. Phoenix also has one of the best job markets in the country and more tech companies are expected to venture into Phoenix. I expect desirable areas in Phoenix metro to surge in appreciation long term but wage increases must follow to keep up with the cost of living.
If you can buy a few multifamily properties in a B or C class area for below market value in Phoenix, you will be set for life, however multifamily properties have been drastically overpriced the last few years. You can also house hack by purchasing a 2-4 unit property and renting out the other units. This is something anyone can do and I highly recommend it if you want to scale your net worth and don’t have a lot of capital. You can practically live for free when you house hack but you should have a smart exit strategy when you decide to move out by either selling the property or renting out the last unit and cash flowing. 2-4 unit properties qualify for FHA loans which allow you to put down as little as 3.5%. Also, 2-4 unit properties that are OWNER OCCUPIED are exempt from fair housing rules which means you can deny someone from renting from you for any reason. You don’t even need to give a reason as to why you denied someones rental application. I would recommend reading Brandon Turner’s book “Managing rental properties” if you decide to go this route or hire a property management company after you purchase the property. You can also house hack by purchasing a single family home and renting out the other bedrooms although this can get uncomfortable. Single family homes do appreciate at a higher rate than multifamily properties.
2. Amortization
Amortization is the paying down of your loan principle which is not the interest portion. Your net worth is determined by deducting your liabilities from your assets. When you pay down your mortgage every month, it decreases your liabilities while the appreciation portion increases your assets. Thus, if you pay off your mortgage within 15 years, you will ultimately pay less interest in total, have zero liabilities and own an appreciating asset outright. Housing costs are the largest expense of a household so once that is removed from the equation, you have more capital to work with. The only reason you wouldn’t pay off your home within 15 years is if you expect to use the capital to invest in appreciating and cash flowing rental properties. Other then that, I recommend paying off your home as fast as possible to have a peace of mind. Going into debt for every purchase in life is not a good idea and when you do go into debt for certain purchases, it should be calculated and make sense financially.
3. Cash Flow
When you invest or house hack in real estate, you should be getting positive cash flow. Cash flow is calculated by taking the gross rent, deducting it by a vacancy percentage which is around 10%, deducting operating expenses and then deducting your mortgage payment. Operating expenses should include a capital expenditure reserve to save for large replacements such as roofs and hvacs. Generally, a cash on cash return above 10% is considered good but it is more difficult to obtain in today’s market. Cash on cash return is calculated by taking the yearly cash flow and dividing it by the cash you put into the property. For example, if you put down $50,000 on a $200,000 property before closing costs and expenses and you cash flowed $2,000 per year after expenses, your cash on cash return would be 4% which is atrocious because it would take you 25 years to recoup your initial cash investment of $50,000 before appreciation. Smart investors do not invest based off of assuming appreciation alone, you must also have a high cash on cash return which is where the passive income is generated from. Passive income is not generated through appreciation.
4. Tax Benefits
When you invest in real estate, you get to deduct depreciation which will usually cause your cash flow for tax purposes to show negative even though it is positive. Depreciation is a non cash expense. When your rental property shows negative cash flow for tax purposes, you end up paying no income tax on the property and can even deduct the loss against other income in certain circumstances. When you go to sell, you also have the opportunity to use a 1031 exchange to buy another property to defer your capital gains and avoid paying taxes once again.
5. Benefit of Inflation
Your mortgage payment stays the same for 15-30 years which means you benefit from the annual 1-2% inflation rate where the cost of goods increase while your mortgage payment stays the same. Currently, mortgage rates are around 3% which is historically low and no, do not buy “more house” just because interest rates go lower. “More house” causes people to act emotionally and not rationally. If you obtain a larger mortgage, you should have 6-12 months in an emergency fund to pay for downturns in the economy and hope that your property value appreciates.
If you need anything or are looking to buy or sell in the future, save my number as “Realtor Lasker” at 480-779-8579 and call or text me with any questions. You can also email me at TaxesAndRealty@gmail.com. Good Luck.
