There are two basic approaches to investing in real estate. One is to acquire properties for short term gain; the other is to acquire properties for long term appreciation and eventual cash flow.
The first approach can yield significant profits that are taxable as ordinary spendable income. The second defers income in favor of long term wealth formation.
In highly aggressive sellers markets, like we have today, some people hope to get in and out quickly with significant profits. Buying, remodeling or improving, and then selling for a quick profit is a very legitimate pursuit. This approach often falls into the category of real estate speculation. Remember, with short term investing you always have federal and state income taxes to consider.
If your cash reserves are limited, short term investing may be attractive. This approach can help accumulate capital for later long term investing.
When discussing real estate investments with our clients we always try to communicate our real estate investing philosophy. We strongly advocate acquiring property as long term investments. As an example, if someone acquires a $1 million property they might make an after tax profit of $100,000 on a short term sale. That would then become spendable income.
If that same property is held and appreciates at 5% per year, in two years they would gain the same $100,000. And, the property would continue to appreciate by the same amount every two years. Over time the increase in equity can be borrowed (or leveraged ) to acquire another property that will then become another appreciating asset for the owner. That appreciating asset is not taxed until it is sold. Over time the owner will have two properties that can be leveraged to acquire additional properties. And as time goes on, these properties will also be producing spendable cash flow.
Over a period of many years the growth in equities and cash flow can be huge. We have many clients that we have helped with this approach over the years. Most of them have equities of multiple million dollars. On the other hand, the $100,000 after tax profit from a short term sale will normally be long gone.
We firmly believe that long term investing is truly the best way to become financially independent, create wealth, and generate passive income.
This article was published in the San Francisco Examiner.
Articles are written by Eric Ruxton and Larry Aikins, owners of Terrace Realty, Inc. and Terrace Associates, Inc. in Redwood City. Terrace has been in business more than 55 years and in addition to being an independent Brokerage Company, also owns and operates rental properties.