This is from TOM LUNDSTEDT CCIM TOMLUNDSTEDT.COM a truly terrific teacher, speaker, and real estate investor. He knows what he is doing. In addition to teaching in the prestigious National Association of Realtor’s GRI Program he teaches other groups, consults and has written instructional books and cds.

THE PURPOSE OF THIS ARTICLE is to give a friendly whack upside the head to people who own rental property You probably made a good investment when you first bought the property. But have you owned it too long? 
Depending on how long you’ve held your property, it might not be a good investment anymore. I didn’t say not a good property; I said not a good investment. Read on to find a simple way to determine if your property is still measuring up. You may be in for a surprise!

First, lets quickly review the four financial benefits of owning investment real estate:

1. CASH FLOW: After you pay all expenses and loan payments, cashflow is the money left over.

2. PRINCIPAL REDUCTION: The loan is paid down with money collected from tenants.

3. INCOME TAX SAVINGS: IRS rules allow property owners to take depreciation deductions, which shelter the cash flow and principal reduction. Any leftover depreciation creates a paper loss, which, in many cases, can be used to shelter other income- such as salary from your job.

4. APPRECIATION: Over time, theproperty increases in value.These four benefits are powerful! You earn tax-sheltered cash flow, your tenantsbuy you the building, you get to tell the IRS you’re losing money, and all-the-while, the property goes up invalue. What a country!
So why am I challenging you toreconsider whether your property is still a good investment? Simple! Your “return on equity” is probably low -and getting lower by the year! Let me show you an example. Don’t get all tangled up in the numbers. Just concentrate on the big picture and how it applies to you.

Return on Equity Drops from 18 to 7 Percent
Assume you bought a rental house 16 years agofor $70,000. You invested $10,000 and borrowed the rest. Your goal is to retire in another15 years and use the rental house to provide retirement income. (A great plan!)
So, how good was your investment 16 years ago? Let’s total your benefits. Assume the cash flow, principal reduction and tax savings added up to$1,800 that first year. You were earning 18 percent ($1,800 divided by $10,000) on your investment. Not bad. Plus the rental house was appreciating. You’re an investment genius!

Fast-forward 16 years to the present.
Let’s assume the following: Your yearly cash flow hasincreased to $5,000 and the principal reduction is $2,000; a total of $7,000 – just from the first two benefits! In addition, let’s assume the net value of your rental house has appreciated over the years so it’s now worth $120,000 and your loan has been paid down to $40,000. However, because you’ve owned the property solong, the depreciation deductions (assumethey’re $3,000) are no longer enough to shelterthe $7,000 of cash flow and principal reduction.That leaves $4,000 of unsheltered (taxable)income. Instead of saving tax, you have to pay tax. If you’re in a 35-percent bracket, (combined federal and state), you pay $1,400 tax. So, your benefits from the rental house now look like this: $5,000 cash flow, plus $2,000 principal reduction, minus $1,400 tax paid. A total of$5,600.

This is all summarized on the “Return on Equity Worksheet” on the next page. (The blanks in the right column are for you to use on your ownproperty.)

It’s no wonder you consider yourself an investmentgenius if you measure the $5,600 againstyour original $10,000 investment: that’s a 56percent return. But that’s where most people gowrong!

Your Original Investment Has Nothing to Do with Today’s Rate of Return!

Your investment is not the amount you originally invested years ago. You’ve got way more than$10,000 “tied up” today! Your investment is the amount you could get out of the property if you sold it today. That’s called your “net equity.” Over the past 16 years, your property has increased in value and your mortgage has been paid down. The current difference between theproperty’s net value (after selling expenses) andyour mortgage balance is $80,000. In other words, if you sold the property today, you couldwalk away with $80,000.

However, if you keep the property, in effect you’re re-investing the $80,000 into the property. Now, how does your investment look? Not so good. You’re earning $5,600 in benefits on an $80,000 investment – that’s only 7 percent! What if a REALTOR® called you up and said, “I’ve got a great real estate investment for you. You’ll earn a measly 7 percent.” You’d hangup on them! Well, you already own it! If you wouldn’t buy a property like that, why would you continue to own it?

What if you did this instead? Use your $80,000equity as the down payment on a different property- one that produces 18 percent again? With that down payment you could probablyafford a $400,000 rental property. Once you’ve owned that property for a few years, your equity will have grown again (and your rate of return fallen), so you repeat the process. The goal is to maintain the highest possible rate of return, which will make a huge difference in your future wealth. 

You’ll maximize your wealth by wisely moving your equity from your current property to another as soon as your rate of return would be greater in the next property.
Just for fun, take out your calculator and figurehow much money you’d have in 15 years if youleave the $80,000 invested at 7 percent. Thencalculate what $80,000 invested at 18 percentgrows to in 15 years. I could give you the answerbut you might not believe me – check for yourself… it’s gigantic!

Three Ways to Move Your Equity

Here’s a key point. If you decide it’s time to “move your equity,” be sure to explore all your options.

There are three common ways to move equity:

1. SELL: You could sell your current propertyand buy another. The problem with selling isyou have to pay capital gains tax.

2. REFINANCE: You could refinance your currentproperty and use the loan proceeds to buyanother property. The problem with refinancingis you’re probably not able to borrow the entire$80,000 equity.

3. EXCHANGE: The third, and best, way tomove your equity is to exchange. Exchanging allows you to move your entire $80,000 netequity to another property without paying tax. It’s wealth building’s most powerful tool. So, what does this all mean? Well, if you own rental property, congratulations. Your investment brilliance shines brightly. However, the longer you own that property your glow begins to fade. The wise thing to do is re-evaluate your propertyevery year. In essence, make the decision to “rebuy” the property. As soon as the rate of return on your equity could be higher in another property, it’s time to take action.

HERE IS A COPY OF TOM LUNDSTEDT’S ARTICLE

This material is designed to provide information about the subject matter covered. The accuracy of the information is not guaranteed. This material issold or offered with the understanding that the author is not engaged in rendering legal, accounting or other professional services. If legal advice or otherexpert assistance is required, the services of a competent professional should be sought.