There are four different ways to make money in real estate:
- Cash Flow
- 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.
To Your Wealth!
Dennis Bethel, M.D.
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.