The authors of Investing In Real Estate, Andrew McLean and Gary Eldred (2006, John Wiley & Sons Inc.), have provided that primer, listing eight ways to grow your wealth in investment real estate.
The key to building true wealth in real estate is through buying and holding. A good tenant can create wealth for you by paying for the mortgage, insurance, taxes and monthly fees through their rental payment to you. In addition, consider this: you have just taken over an asset leveraged by a fraction of the value. In other words, let’s say you purchased a condo at $150,000 for $15,000 down payment. If it grows at 5 percent per year ($7,500 first year, etc.) you’re making more than 50 percent on your money that you actually invested — can’t get that kind of power behind mutual funds.
Real estate investing allows investors several ways to make and/or save money that other investment tools will never allow or have the ability to provide. As Mr. McLean and Mr. Eldred point out, no one can predict short-term price increases — but that’s why the savvy investor doesn’t look to just appreciation to make money. Here’s how you can build wealth through your real estate investing:
- Positive cash flow. This is simply what it sounds like — the rent covers the mortgage, taxes, insurance, fees, etc., and once all that’s paid, you have money left over at the end of the month. A wise investor will also have enough money in reserves to cover all these expenses for a few months in case the property goes vacant.
- Equity growth via amortization. As the mortgage shrinks from the mortgage payments, your equity grows (and so does your net worth). This is one of the most powerful means of wealth growth — using OPM (other people’s money) to build your net worth. The tenant is providing the investor with hundreds or thousands of dollars per month to pay off debt, which turns into equity for the landlord.
- Capital improvement. This is the fixer-upper that most people think about when investing in real estate. Purchase a property for $50,000, put in another $25,000, and voila, the house is now worth $125,000 ($50,000 more than the initial investment).
- Wholesale purchases. The most effective way to build net worth and equity is to buy a house for a bargain price. These properties would be the pre-foreclosure, foreclosure, tax sales, etc., where the investor buys the property well below market price. In essence, you make your money when you buy the house at such a low rate.
- Lowering tax bills. One of the greatest benefits about real estate investing is all the tax breaks allowed for these type investments. Uncle Sam allows many tax deductions, tax credits and other government-sponsored programs connected with real estate investing that cut the investor’s tax bill, thus, increasing the bottom line and equity growth.
- Smart asset management. Many novice or ignorant real estate investors lose money simply by not managing the asset wisely. For instance, painting properties before the wood is actually peeking through will keep the asset in good shape, seal the wood, and protect it from more expensive damage. Managing the asset is just as important as buying smart and cash flow. The real estate investment is a commodity, not a money machine, and must be managed and protected to maintain future wealth growing potential.
- Asset value growth. As your property increases in value, so does your wealth. This is the old fashioned principle of buy and wait. Buy at today’s prices and with time, your asset will grow in value because of local appreciation. In addition, your equity will grow along with the amortization principle mentioned above.
- Rent appreciation. As the cost of living increases, so, too, should your rent cash flow. Increasing your rental income per month by 5 percent could result in hundreds of dollars of cash flow per year — year after year.