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Learn to use the same concepts in your situation that the professionals use in their real estate projects.
These tactics and limitations include the following:
1. State homestead protection (only in a few states and still wasting the equity).
3. Limited liability companies (LLCs)/ family limited partnerships (FLPs) (lose significant tax advantages to home; mortgage trigger).
4. Trusts (you give away the home to the trust forever).
In this second part of the series, we will examine the ideal strategy for shielding the home, which provides tremendous asset protection and allows one to build wealth out of home equity.
Before we examine the ideal strategy for shielding the home and building wealth, one must first understand a few basic principles about real estate investing. Real estate investing is like medicine, law, or any other field-you either learn from trial and error (which can be costly) or you learn from watching and studying the experts. If real estate magnates can create billions of dollars of wealth in real estate, they must be doing something right.
Would you believe that they are all following the same economic concepts? It is true. From the development of a 100-story tower in Manhattan to the purchase of a family home, the same fundamentals apply to every deal. It is important that you learn to use the same concepts in your situation that the professionals use in their real estate projects. With this knowledge, you can protect your home and build wealth at the same time. Let's examine them now:
1. Equity versus fair market value. Most physicians operate under a misunderstanding that real estate professionals reject: equity = wealth. This couldn't be further from the truth. In fact, it is more accurate to say that equity is as a cost. Professional real estate investors call equity the "opportunity cost." In other words, it is the amount of capital they have to invest to purchase the entire piece of real estate, with the rest coming from financing (debt). They try to minimize this as much as possible.
Consider the following example:
You purchase a home for $500,000. You make a down payment of $100,000. Your mortgage amortizes over 15 years and you pay interest and principal until the home is ultimately paid off. Assume that, after 5 years, the value of the home has increased to $700,000 and you have paid down the mortgage from $400,000 to $300,000. If you sell, you will net $300,000 pre-tax.
I purchase the same home with the same increase in market value over 5 years. The difference is that I have an interest-only mortgage. Rather than pay down the $100,000 on loan principal over the first 5 years as you did, I invested my $100,000 and gained 8% on this investment. At 8%, it grew to over $147,000 at the end of year 5. When I sell both the home and the investment, I net $347,000 pre-tax.
By choosing to invest my extra capital rather than "build" equity like you, I increased my wealth by 16% more than you over only 5 years.