Real estate has many avenues for producing income. In more expensive markets such as Vancouver and Toronto most investors purchase for capital appreciation/gains. Some investors flip and others decide to use the BRRR (Buy, Refurbish, Rent, Refinance, Repeat) strategy. But if real estate is truly “passive” the ideal way to build wealth in real estate is to buy and hold cash-flowing rental properties.
The financial crisis of 2008-09 and the recent Covid pandemic has created a lot of uncertainty in the housing market. Regardless of market conditions, here are a few ways to build wealth through real estate that can help you invest and build real wealth both short and long term.
Here are five primary advantages to building wealth with real estate:
- Cash flow
- Appreciation – Hedge against Inflation
- Infinite Returns on Investment
- Taxation benefits
Cash flow is often referred to as the holy grail of finance. When a investor claims that a business has sound business fundamentals they are most likely referencing its’ cash flow position. It is the money that remains after all expenses are paid. Since, cash flow is binary (positive or negative), the direction of its’ flow determines whether it is an asset or liability to the owner. If your rental property is purchased as a rental property, it is important to insure that it provides you with cash flow needed to sustain it’s very own existence.
In Canadian markets such as Vancouver and Toronto, finding properties that cash flow is non-existent with the current housing market. However, there are markets throughout Canada that exist where rental properties make positive cash flow and a sound investment. You just need to know where to look.
A good starting point is to look into cities and communities that are growing horizontally and not vertically (high rises). Communities where new families are moving or relocating due to work opportunities or education. Investing in expanding markets will avoid decreases in rents and/or vacancies.
Appreciation and Inflation
Unlike cash flow which is instant, appreciation is the slow but steady turtle – increasing value over time. While I’m more interested in cash-flow, appreciation is a powerful hedge against inflation. As you’ve probably noticed; the Canadian government has printed an unbelievable amount of money over the past year. This means that the value of money is decreasing, thus causing inflation – where the value of real estate goes up.
Savers always lose. For example, if you put $100 in the bank at a nominal .03% interest rate and the inflation rate is 3% (Government published rate) you are losing money. But if instead, you put that $100 into real estate you’re coming out farther ahead. Essentially hedging against inflation.
Leverage is basically applying a little amount of force to create a much larger outcome. It is the quintessential tool for the real estate investor. Leverage creates an economic lever that flows between the bank (or lender) towards the owner (borrower).
Example: When you decide on making a purchase and get money from the bank to buy a cash-flowing rental property. You bring only 20% to the table as the down payment and the bank brings 80%. As the owner you get 100% of the profits, appreciation and tax benefits with only 20% of your own money. Your partner, the bank, only gets your monthly payment with an extremely low interest rate. This is the principle of leverage being applied and it is a powerful way to build wealth.
Infinite Returns on Investment
In no other investment opportunity can you receive infinite ROI while still owning 100% of the asset. Real estate affords this opportunity through its own organic asset appreciation. In fact the banks assist you with this process every time you need to renegotiate your financing terms every 4 to 5 years.
Infinite returns is a powerful way to maximize returns while reducing risk, which is essentially the end game of investing. Infinite returns on an investment occur when you no longer have any money in a deal, but you still receive 100% ownership and the benefits of cash flow.
Example: Suppose you make a purchase of a $400,000 property that is cash flowing positive or even breaks even. Your initial investment would be the 20% down payment which is $100,000 and the bank would finance the rest. Then after 5 years, let’s assume that your asset appreciates to a value of $500,000. At that time you go back to the bank and they will refinance based on a 20% down payment. You would then receive $100,000 back from the refinance. Essentially your entire initial investment would come back to you (tax free), while you still own the property. You could then use this money (tax free) to fund another deal or pay down another mortgage. Which leads us to the last benefit…
Wealth in real estate comes from knowledge of debt and taxes. Debt is tax free money and so is money received from appreciation gains from refinancing debt or a properties mortgage. Therefore, if you receive cash back on your property refinance, there is no tax on that money as it is still debt.
Furthermore, with trust documents and proper corporate structures in place, most of the revenue can have minimal tax burdens. However, if you purchase properties under your personal name, the incomes are shown as part of your extra income on your personal tax return and will be taxed at the same rate as your taxable income.
With rental properties that are furnished with appliances there is an added depreciation component. It allows owners to write off some parts of the property’s assets on a yearly basis. However, like any tax-related questions, it is best to consult with professional accountant and Trust lawyer on your personal portfolio in order to see if a corporate structure could benefit you based on cash flows you receive from your investments.
My advice is to take your investments one step at a time. Don’t get overwhelmed, as there are too many moving parts. But remember that real estate is an amazing tax shelter once you know how to play the game. We just need to continue learning and get better at it. Feel free to connect with me. I enjoy investing and continually embrace learning and perfecting the art of investing.