Although the real estate market has plenty of opportunities for huge profits it is far more complicated the profits and losses could be extreme. It is capital intensive and cash flow dependent. These features are to be managed by the investor otherwise the investment could be risky. The realtor should take into consideration cash flow, leverage, equity, appreciation, and risk of investing in real estate. It requires time and effort to stay on top of things.
Cash flow is the financial potential of the land or property which differs from place to place. It depends on the state of the local market, interest rates. Cash flow is generated for the investors through net operating income (NOI), tax shelter offsets, equity build-up, and capital appreciation.
NOI is the positive cash flow from the rental income of a property after operating expenses. The operating expenses include maintenance, taxes, utilities, supplies, insurance, accounting, etc. Always make comparisons of the alternative available. Perceive whether it is a short-time investment or a long-time investment.
Real estate is the most effective tax-sheltering means available as property taxes are deductible. Real estate can be refinanced and non-taxable cash as income can be obtained. Investors use tax shelter methods to reduce tax liabilities which includes legal shelters like depreciation, tax credits, and carryover losses.
Equity build-up is the increase in the investor’s equity ratio due to the monthly debt service payments of the principal. In simple terms, it is the difference between the mortgage or the loan and the actual market value of that property. It gradually reduces the loan amount. It can occur naturally or be forced. The natural appreciation involves holding the property for a long time and covering the mortgage, taxes, and insurance with the rental income and finally selling it for more than paid for it. Forced appreciation depends on the efforts made by the investor by buying the property at a low price and then reselling it soon creating instant equity. Capital appreciation is the increase in the value of a property over time due to inflation, supply and demand, and capital improvements. Appreciation can also be affected by labor cost, cost of land, cost of construction material, construction fees, etc. Though it is an unpredictable aspect the investors should have an understanding of the aspect that will make real estate appreciate. Leverage is the determining factor in real estate. Real estate leverage can be an effective tool for multiplying the return on investment, whether positive or negative. The investors have the chance to increase their return on investment. It can help in making financial moves in relaxed ways. The investor leverages his asset through a mortgage. The return on investment of real estate increases the wealth of the investor. But if the effect is negative, the loss is more than the amount invested. Hence, leverage should be used cautiously. There is a lot of potential in the real estate but for assured profit, careful choices have to be made and cost and benefits have to be weighed.
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