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Why Cash Value Insurance is a Valuable Real Estate Tool
Whether you’re an amateur or long-time veteran, a smart real estate deal always starts with research. So how do you properly analyze a real estate deal? Whether you’re looking at a residential property, or an investment, don’t go in without doing your due diligence. That’s where the Real Estate Analysis calculator comes in.
Let’s start with a real world example. A couple, after making some wise decisions about their financial strategy, had some available capital to do with what they liked. And when you’re in a position of cash, opportunity finds you.
They had long dreamed of a vacation home, when a friend approached them with an offer. He was looking to sell his cabin in order to have money to continue investing in his business. Though the cabin was appraised at $150,000 he was willing to sell it to friends for $100,000 if they were able to close in ten days’ time.
They’d visited, and knew the cabin was nice. In fact, $100,000 seemed like a bargain to them.
All things considered, the deal seemed like a dream. The only thing missing was certainty.
Real Estate Analysis is a tool for homeowners and investors alike to determine the viability of their purchases. This calculator is fairly straightforward, all you need are the numbers. As an advisor, this a valuable resource in helping investors and homeowners who are making big real estate decisions.
In addition to the property value and the purchasing price, the couple knew that closing costs would be 3%, or $3,000. The land value itself was $35,000. Monthly property taxes, maintenance, and insurance could all be priced at $200 a month. In addition, they planned to pay for the property in cash.
Analyzed over 15 years, here’s how their rate of return calculates:
If the ROR looks low, that’s because it is. Yet that’s not where the story has to end. Though many would say real estate is about three things–location, location, location–there’s something even more important than that. Financing.
The couple’s next idea was to rent out the cabin when is wasn’t in use. Their friend was using the cabin for rental income for an average of ten nights a month, all throughout the year, for $150 per night. So in Gross Rental Income, you’d add the $1,500. The Monthly Cash Flow will then recalculate.
Here’s the result:
Just by adding in some rental income, the ROR bounces up to 13.32%. And the couple would still have a getaway cabin for 20 days out of the month. They’d also receive a nice income of $900 each month. The couple could have stopped here, and decided that the deal was worth it for them…yet there’s more to consider.
To take it further, it’s important to consider exactly how the cabin is being financed–not just through rental income. Is paying cash for the cabin really the best option? Many Real Estate Investors know the importance of using “other people’s money,” yet still pay for their properties in cash.
Instead of paying in cash, what if the couple focused instead on a 20% down payment? They could likely get an institutional loan of $80,000 at about 5%. Over that same time frame of 15 years, here’s what their ROR would look like:
Now this couple has cash value life insurance, with cash value well over $100,000. What if they were to take a loan against their own policy? And instead of using their own cash for the down payment, they used their policy loan for the whole mortgage?
Now their ROR is is 48.46%, which is the best ROR they’ve seen. Yet their monthly cash flow is only $109. They were really looking forward to having more cash at the end of the month. Life insurance, however, gives them more control and leverage in the deal. Maybe the bank would only approve a 15-year mortgage, yet with life insurance, they can set the amortization schedule.
Suddenly, their ROR skyrockets to 165.28%, and they’re anticipating a positive cash flow of $363 a month. Taking a longer amortization period, on top of rental income, provides them with greater cash flow without the obligation to pay $103,000 in cash up front. And not only is the cash flow positive, it’s better than what they would have gotten in an 80% loan from the bank.
We’d be remiss if we didn’t cover taxes. So how do the couple’s taxes affect this real estate deal?
For the sake of ease, let’s say they’re in the 25% tax bracket, their capital gains are 20%, and the Depreciation Recapture tax bracket is 25%. Add those in, located in the center column, and their ROR is back down at 38.12%.
Although taxes reduce the ROR, 104.75% a fine rate of return. While there may be some deductions available, it’s important to consider the impact of taxes on any purchase. Without the proper understanding of them, expectations can be unrealistic–and it’s a good idea to cover the possible impact with clients, so they’re not blindsided. Any deductions available down the road will make the impact of the deal even better.
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