There are four different ways to make money in real estate:
- Cash Flow
- Appreciation
- Tax Benefits
- Principal Reduction
Can you think of another investment where you can derive four separate benefits?
Real Estate Investment Cash Flow
The amount of money available to the investor from rents and other income after operational expenses are paid constitutes your real estate investment cash flow.
This monthly, quarterly, or yearly distribution of income is cash in your pocket to be used as you see fit. I like to think of it as incremental return of my initial capital investment which reduces my risk exposure over time.
While working as a physician, I universally reinvest these funds in new investments. Ultimately, when my cash flow exceeds my monthly living expenses, I can live on that cash flow and retire from medicine if I wish.
Real Estate Appreciation
With residential real estate, it can be difficult to count on any real estate appreciation.
Investors are beholden to the residential market cycle and comparison appraisal model. As such, many investors have been trapped in a down market unable to refinance due to a poor appraisal environment.
However, this situation is different with commercial real estate. Commercial real estate follows a business model.
As such, the value of a property is determined by the following formula:
VALUE = NET OPERATING INCOME (NOI) / CAP RATE
The business of property management and asset management revolves around the numerator of the above equation. By increasing rents and rental retention as well as decreasing expenses, quality managers can force appreciation of your investment.
Real Estate Tax Benefits
Real estate is one of the most tax-advantaged, if not the most tax-advantaged investment out there.
Depreciation is a gift that can allow many investors to take their cash flow tax-free.
Additionally, there are strategies and policies in the tax code that allows one to either harvest their equity tax free or defer the tax to a later date.
Growing one’s nest egg in a tax advantaged way can add a multiplying effect that accelerates one’s wealth. This is the reason so many people max out their IRA and other retirement accounts.
The downside to those accounts is that you can’t touch your retirement money without significant penalty until you are 59.5 years old.
What if you want to work part-time or even retire much sooner than that? With real estate, many investors can accumulate enough cash-flow to retire sooner than they thought possible.
Real Estate Principal Pay down
Just as your renters pay for your operations and capital improvements, their rent also pays for the debt service or mortgage payment. With commercial real estate it is not uncommon for the principal to be reduced $50K, $100K, or even more annually.
No doubt, this drastic reduction impacts the investor’s internal rate of return and assists in future liquidity events.
How do real estate investors make money?
By making smart investments in commercial real estate and taking advantage of the four different ways to make money in real estate. Actually it is easier and safer that you ever thought possible.
P.S. If you’d like to learn more about creating stable streams of passive income outside of medicine by investing in commercial multifamily real estate, then download your free copy of Evidence Based Investing.
Want to learn more?
Download your free copy of Evidence Based Investing and learn why it’s a preferred asset class.
With a single family home a vacancy wipes out 100% of your cash flow. In a 100 unit building, a vacancy only takes 1% of your cash flow. What investment seems smarter/safer to you?
Not all real estate investments are built perfectly, and there will be times when the market may be down, or things need to be repaired, but having the four different benefits allow you to hedge your bets and make money in multiple different ways, and this is unmatched by any other type of investment. If you can really grasp this concept as an investor, you will see why commercial real estate is the safest way to build permanent wealth. Great information – this should be required reading for every investor before they make the decision on where to invest their money!
Thanks Pete. I don’t know of any other investment that gives you so many financial benefits. Cash-flow, appreciation, principal paydown, and tax-benefits. I like to call that multisource income. Its no wonder why you can get superior returns with real estate when you do it right.
Commercial property is undoubtedly an excellent and stable investment but for the same reason, it is also likely much more expensive , and difficult to become an independent owner of an asset with good market value. People don’t just sell unless its a good opportunity for them also and then you’d be competing with much deeper pockets.
Except through REITs or such funds, how does one individually get involved with such valued and appreciating property ??
Hello Ram,
Thank you for the comment. In every market, there are good deals to be had. If you like active investing and going at it alone, you will likely be constrained to residential properties (1-4 units). These do not have economies of scale and therefore, I do not recommend them. Having said that, there are people out there making money in the residential space.
For me, I would rather remain passive and get all of the benefits of real estate without having to become a landlord. I do this through direct fractional investing which allows me to be a part of much bigger deals that have better cash-flow and appreciation due to economies of scale.
If you would like to learn more, follow this link:
http://www.nesteggrx.com/passive-investment-fractional-ownership/
Income property is an excellent buffer compared to single family homes. Although the SFR tend to appreciate quicker in high demand markets.With more units you have , the more potential for headaches from tenants and insurance costs go up. Things tend to equal out whichever way you decide. If it were me, I’d get a multi-family though anywhere from 4 to 20 units.
Hello Reggie and thank you for the comment. While I respect your opinion, I will have to disagree. Single family homes are beholden to the residential market cycles and the comparison appraisal model. Multifamily on the other hand, follows a business model in which you can force appreciation through improving net operating income. If you get caught in a downward residential cycle, there is little to nothing you can do to avoid declining values. These cycles can be long and painful.
Also, there is no economies of scale with single family homes. I’ve done both residential and commercial. For me, commercial works the best. I do agree that independent purchase of a large multifamily property can be beyond most individual’s reach. However, direct fractional investing has solved that problem allowing investors to invest for around the same down payment they would have to make on a triplex.
Greetings! I’ve been following your web site for some time
now and finally got the courage to go ahead and give you
a shout out from New Caney Texas! Just wanted to say keep up the good work!