Understand Returns to Make Money in Real Estate
Many people purchase real estate with the hopes of earning wealth like they would with any other investment asset. However, real estate is unique in that it has four distinct components of investment return: appreciation in value, cash flows, income tax benefits and mortgage principal pay down. Just because there are multiple components of returns, you aren’t guaranteed to earn money on real estate investments. Protect yourself by doing as much research and analysis as possible before you make the purchase.
Appreciation in Value
Most investors buy property with the thought that it will appreciate in value and they’ll get rich. Unfortunately, real estate does not always go up in value. Over long period of time, 15 to 25 years, real estate seems to perform well and has earned wealth for many long-term holders. However in the short term, don’t count on appreciation because it won’t pay your bills. It’s always better to invest based on cash flows than on appreciation in value when buying investment properties.
Cash Flow Positive
Many real estate investors don’t understand how to pencil out their real estate deals. What this means is putting conservative estimates of rent and expenses down on paper and making sure that the rents, less all of the expenses, leave the owner with cash in the bank. These are known as cash flow positive properties. Buying properties with true positive cash flow is the best way to ensure that your investment increases your wealth. Far too many buyers purchase negative cash flow real estate and take extra money out of their bank accounts for years to come in order to cover the deficit. Doing this is not a way to successfully invest your hard-earned capital.
Income Tax Benefits
If you own rental properties, you may be eligible for income tax benefits; benefits means that because you own the property, you pay less in taxes than you would have to if you didn’t own the property. Unfortunately, most investors don’t know how this works. If you are self-employed and pay little in taxes or your income is greater than $150,000, you probably have little tax benefit from real estate ownership. Before you start to count on tax benefits from your investment, consult with a tax pro who can tell you whether or not you will actually be able to save money.
Mortgage Principal Pay Down
If, like most people, you have an amortizing mortgage, you may realize some return. Every monthly mortgage payment pays the accrued interest and a bit of the outstanding principal of the mortgage. That principal is pure investment return and it can help you see incredible returns, however, it does not provide cash flow.
While each investment return may help your long-term wealth, it is the cash flow component that is the most important. Cash will pay your bills and you can put into a bank account so it can earn you interest as well. If your investment doesn’t generate cash, you won’t be able to pay the mortgage and you could end up losing the property. Be sure that you understand investment returns to realize the largest wealth possible.