Real Estate Investment Analysis
All of those calculations that go into a thorough analysis of the financial viability of a real estate rental property can be a pain to learn. Then you have to apply them and pull them together to make a decision:
- Gross Potential Income (GPI)
- Gross Operating Income (GOI)
- Gross Rent Multiplier (GRM)
- Cash Flow Before Taxes (CFBT)
- Cash Flow After Taxes (CFAT)
- Net Operating Income (NOI)
- Capitalization Rate (Cap Rate)
- Break-even Ratio
- Return on Equity Year One
Why We Go to the Trouble
Investing in rental real estate is drawing more interest than ever. When you read or watch on TV about fix & flip investors, they're often selling those homes to rental investors. The successful rental home investor may have dozens of homes in their portfolio. They are sharp investors, or they wouldn't be raking in cash flow from that many homes. You'll want to be able to understand and discuss the "numbers" with them. Let's take a look at the benefits of rental property investing.
The depreciation deduction is a valuable component in our property analysis. For people in high tax brackets with other investments, it may even allow reducing the profits from other investments. Of course, contact an accountant about this. However, when the costs plus depreciation actually are more than the profit number for taxes, you have leftover losses to use against other investment income.
It's not actually a cash loss, as the depreciation isn't cash out of pocket. It's a calculated number treated as an expense for tax purposes. Since you didn't spend it, you can still have positive monthly cash flow while showing an operational loss for taxes.
Taking monthly cash flow to the bank is a big draw for rental investors.
Doing their due diligence and buying right can result in double-digit returns and a solid flow of cash for years. Cash flow is a function of a great many inputs, and any or several of them can change and damage or improve cash flow. Some are market and economy influenced. If a major local employer closes or moves, the demand for rental property can plummet overnight. It is something you can't control but hopefully avoid by doing your due diligence about the health and plans of local employers. If they are healthy and profitable with a long lease recently renewed, you're probably in good shape.
You can deduct the property taxes for income tax purpose. If your business owns real property, you must pay property tax on this property. In the same way, as individuals pay property tax on the assessed value of their homes, businesses pay property tax on the assessed value of their real estate (land and buildings). If real estate is sold, the tax for the year is distributed between the previous and new owners, based on how much of the year they owned the property.
1031 Tax Deferred Exchange
You can, under very strict rules, sell a property at a profit and roll the proceeds into another property without having to pay capital gains tax.
Here's what the Internal Revenue Code, Title 26, Section 1031 says: "No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment." Property of like kind simply means other real estate and does not require a land-for-land or office-for-office exchange.
The fact is that there are few investment asset classes and strategies that can compare with rental real estate. People need a place to live, and owning a home is not possible for some and not desired by others.