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By Sia Hasan
Special to the Financial Independence Hub
Gaining financial independence is one of the most difficult propositions. Life is expensive, particularly if you live in a metro area, which is where most of the higher paying jobs are located. As a result, most people save only small amounts of their paychecks or none at all. Clearly, this is not the path to financial independence (aka “Findependence.”).
Thankfully, you don’t have to make a massive salary to become financially independent. There are several methods for building wealth, including starting a business, investing in securities, and investing in real estate. Even if you do the first two already, you need to consider these five ways of increasing your financial independence through real estate.
Real estate investment offers the highest returns for the lowest risk when compared to starting a business or investing in stocks. The reason is that real estate offers five surefire ways to grow your money, known by the acronym IDEAL. By setting a long-term plan to benefit from these five methods of making money in real estate, you are on your way to financial independence.
The IDEAL investment
IDEAL stands for income, depreciation, equity growth, appreciation, and leverage. To succeed in making real estate work as an investment, you need to look beyond your principal residence. Though owning your own home provides appreciation and tax benefits, most people can’t produce income from their principal residence, owners of duplexes and people who rent out spare rooms aside.
1.) Income
When you purchase a rental property, you generate income, provided that you collect enough rent to exceed expenses. With a cash purchase, this is easy. If you finance the purchase, you need to analyze the numbers carefully. Provided you finance the right rental property, you earn a much higher rate of return on the financed property than if you purchased it with cash.
2.) Depreciation
To increase your rental income profits, you need to bone up on the IRS depreciation rules. Because the property is a business investment, you get to deduct all depreciation off of your profits. This saves thousands of dollars in income taxes every year.
3.) Equity Growth
In addition to rental income, you also get the benefit of equity increases. To maximize equity increases, it’s important to understand the components of appreciation. There are two kinds of appreciation: passive appreciation and forced appreciation.
4.) Appreciation
Passive appreciation is the appreciation that occurs without any action on your part. As property values in the neighborhood increase, the value of your property increases with it. In hot markets, passive appreciation can be substantial. More broadly speaking, passive inflation tends to equal the rate of inflation.
Forced appreciation results from enhancements made to the property. For example, adding new landscaping and redoing the kitchen will certainly result in forced appreciation. You can also gain forced appreciation by buying a home at a discount. The best investment properties are the ones you can buy at a discount and enhance.
5.) Leverage
Leverage is a double edged sword. Your ROI on any property increases when you use leverage. The more leverage you use, the higher your rate of profit. If you use leverage to control $1 million of property by putting $100,000 down, a 10 per cent return on the $1 million doubles your money. However, as many investors learned during the mortgage crisis, over leverage can pull you down when the market sours, so use good sense.
Many investors never realize the power of investing in real estate through an IRA. Through a self-directed IRA, investors can use their retirement funds to invest in rental properties. Any funds from a real estate IRA must be used for rentals only. The IRS prohibits using IRA money for any property you use personally, including a vacation home. You can, however, buy a rental property and move into it after you retire, taking it as a distribution.
For a real estate IRA to work in your favor, you need to keep transactions within the IRS guidelines. IRS rules prohibit mortgages on the property and restrict deductions for depreciation or losses. However, buying a rental property in a hot market with IRA money is a great investment. Using IRA funds to purchase a rental property that will become your retirement home is another strategy that pays off big time.
Overall, real estate is a great place to invest in order to establish financial independence. As long as you know where to invest and how to invest in real estate, you will be financially independent in no time.
Sia Hasan is a tech entrepreneur by day, and a freelance writer by night. Her passion lies in business technology, efficient and sleek programming, and customer relationship management. When she doesn’t have her nose pressed against her computer screen, you can find her spending time with the loves of her life, her two dogs, Pixel and Vector.
