When we buy a primary residence, we all understand that its an investment in our future. On average, a person stays in their 1st home for 7-10 years. The average person takes the equity they built in those first 7-10 years to use on their 2nd purchase. In a way, that’s “business” already. But lets take it a step further.
If you KEPT that 1st property and turn it into a rental, NOW YOU’RE REALLY IN BUSINESS. Sure, I know what you are thinking…how do I get the down payment money for my 2nd property to go live in if I didn’t sell the 1st property? Beyond lecturing you “Well, you should’ve been saving your money the last 7 years”, I would encourage you to look at the possibility of pulling the equity from your 1st property by either refinancing or even getting a line of credit. Now you have down payment money for your 2nd home to go live in. YES, you need to make sure the rent on the 1st home will cover your mortgage(s), but this is how so many people get their real estate investing business started. IT WORKS.
Why is this a business and not some silly side hobby? Because when you look at your revenues, expenses and tax’s you’ll see that 1 rental property has more money cycling through it than some “real businesses” do. Lets dig in. Numbers vary depending on exactly where you live but lets use $3,600 a month in rent as a starting point on a house that is valued at $500,000. The math is simple, your BUSINESS now generates $43,200 a year in revenue. That sounds like a lot to me for your 1st year IN BUSINESS! Of course, as any business does, you also have expenses. Keeping in mind you bought this 1st house 7 years ago, lets throw some realistic numbers at this to drive the point home:
YEARLY BREAKDOWN
Rent Revenue – $43,200
Mortgages, Tax, Insurance – $30,000 ($2500/month)
Property Management- $5,530
Utilities- $400
Repairs/Maint. – $1,500
Landscaping- $1,200
Vacancy/Misc- $3,500
BOO! Turns out your rental business only turned a profit in Year 1 of $1,070 after accounting for all expenses. But wait… did you know that MOST BUSINESSES take 3 years before they turn a profit? Put that to the side, we aren’t even finished yet on YOUR BUSINESS FINANCIALS. So you turned a profit of just over $1k on your 1st year after all expenses were accounted for. Now lets add some layers:
-Tax advantages such as Depreciation of your asset. The IRS allows you to DEPRECIATE the value of rental property. Similar to how you write down a business vehicle over time.
-Debt paydown. The mortgage payment, property tax and insurance payment wasn’t paid by you anymore. You took out that debt and now its being paid off by your tenant.
-Appreciation. You knew when you bought this house 7 years ago to LIVE IN IT YOURSELF, that it was a good investment because real estate appreciates. Well, it still is.
Your $1k profit will be written down through depreciation so you don’t pay income tax, your debt is actually wiped out (in a sense) and the property continues to appreciate over the years. You have a healthy thriving business on your hands! Your real profit is not $1,000, it is infinitely more. This isn’t tax advice and we have made some safe assumptions in our example BUT, people are doing this exact thing every single day. Making real estate investing one of the safest ways to start a business in America.