A real estate entrepreneur or a real estate investor to a lesser extent is someone who actively or passively invests in real estate. An active investor may buy a property, make repairs and/or improvements to the property, and sell it later for a profit. A passive investor might hire a firm to find and manage an investment property for him. Typically, investors choose real estate for several reasons: cash flow, capital appreciation, depreciation, tax benefits and leverage.
Appreciation occurs over time, generally, though an investor may "force the equity" in a property by making enhancements to it or the surrounding environment to increase its value. In general, residential real estate is valued by the "comparable sales" method which estimates the value of property under the principle of substitution. The method estimates property values by comparing a subject property to similar properties sold in similar locations within a recent period of time.
Depreciation is one of the many benefits afforded to real estate investors. Though the property is actually increasing in value, the government allows owners to systematically depreciate the property over its projected useful life span. Depreciation is an allowable tax deduction. In addition to depreciation, an investor will usually claim the interest portion of his monthly mortgage payment as a tax deduction.
Leverage is a powerful reason for investing in real estate. If an investor used 100% cash to acquire a house worth $100,000, and the house increased in value by $5,000 in one year, then the investor made a return of 5% (assuming no other costs in this case). However, if the investor obtained 95% financing, only $5,000 cash would be required at the closing table, and a bank or other lender would loan the remaining $95,000 to acquire the property.
Assuming the same $5,000 increase in value, the investor's cash contribution of $5,000 would yield an increase in equity of $5,000 in one year, a 100% return. Of course, leverage works in the opposite manner as well. A $1,000 decrease in value would produe a negative 20% return on the $5,000 investment.
Real estate investing has become quite popular in recent years due to rising property values and low interest rates. Deflation in property values or a sharp increase in interest rates would dampen the market considerably, however.
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