Real Estate: The Answer To Debt, Taxes, AND Inflation?

They say there’s no such thing as a magic bullet, especially when it comes to investing. A multitude of different strategies are used across dozens, if not hundreds of industries and each one works for some but fails for others. In today’s economy, the gap between rich and poor is growing wider, inflation is at a record high, and the debt of the middle and lower classes is growing. With all of that being said, one thing is for certain. Investors need to hedge.

Finding ways to benefit from the wild inflation numbers and come up with strategies that help you leverage debt and avoid higher taxes is key. Doing so will prevent big losses as inflation and taxes continue to rise. It may sound impossible during a time when everything seems so unpredictable, but it isn’t.

Utilize Taxes To Build Wealth

In the world of taxes, it’s really more about what you keep than what you make. If you’re a high-income earner in a place like California, you’re probably losing close to half of your income to taxes. It’s tough to swallow. However, if you were invested in multi-family real estate and earning the same amount of rental income as your employment income, the taxes on your rental income would be substantially lower given all the write-offs in the tax code.

“If your gross rental income is the same as your gross employment income, you will net more cash in your pocket with rental income through better taxation.”

You could then turn around and use that profit to invest in another multi-family syndication. You would be well ahead of what you’d keep from your employment income because passive income is much more favorably taxed - especially when it is providing jobs and housing benefits.

How Investors Use Debt

When most people think about debt, they think of bad types of debt like credit card debt or debt that is used to purchase something that depreciates or doesn’t provide cash flow. That is because too many people spend more than they make and they end up paying excessive fees on credit cards, insurance, and bank loans as a result of their spending habits.

As an investor, however, you can take advantage of debt in a positive way. Let’s look at a simple multi-family purchase. Let’s say you purchase the property using a 70% loan and 30% cash equity. Not only are you leveraging up how large of an apartment project your cash can purchase, but you’ve now fixed 70% of the financing costs in a long-term loan. As cash flow increases through rent increases over time, your cash equity receives a disproportionately higher return because 70% of the financing cost is at a fixed interest rate that doesn't change. 

That leads us to the second benefit of debt financing on income-producing real estate assets. As rent increases, the property appreciates in value. Say the property increased in value from $1 million to $1.5 million. You could borrow against the newly appreciated value via an Equity Line of Credit and pull out the equity tax-free (really, tax-deferred until sale or liquidation). Now you can use the new capital to buy another cash-flowing asset. This is how investors use debt to generate additional passive income that isn’t highly taxed and continue to grow wealth with hard assets.

What About Inflation?

Without a doubt, inflation can be intimidating to anyone, especially inflation like we’re seeing right now. It’s almost as if we’ve been in lockdown for a year and a half. Inflation typically occurs at a slow rate over the course of decades but when an event like a worldwide pandemic occurs, inflation in the aftermath accelerates due to several factors. Similar inflation rates were seen back in 2008 when our country was in a different type of crisis. 

The good news is that inflation actually benefits real estate investors, particularly those invested in properties with short-term lease structures, like multi-family properties. Higher inflation rates mean higher rental rates and thus, provide more income for the investor. As rent increases, it lowers the loan-to-value of any mortgage debt, creating a natural discount and higher valuation. Lastly, real estate has always been a good hedge against inflation because property values over time tend to stay on a steady, upward curve. This is particularly true for apartment assets and even more so for assets in regions with high job growth and extremely low vacancies - like the Inland Empire. Not only that, but in California, the high barrier to entry to develop and build new apartments is very challenging, creating natural protection for any assets that do get built and almost ensuring strong long-term valuation growth.

If there is no magic bullet in investing strategies, multi-family property investments might be about as close as it comes to finding one. You’ll be generating passive income that isn’t highly taxed, using debt to create additional cash flow, and hedging against inflation. 

“In these unstable times, investors should seek stability in multi-family properties.” 

If you’re interested in investing in one of our multi-family developments in the hottest market in the country, contact us today to discuss how you can get started today on your journey to financial freedom.