Did you know that 90% of the world's millionaire invested in real estate to create their wealth?
It's why headlines like the following are even possible:
Self-made millionaire went from janitor to real estate mogul.
Real estate is the fastest and easiest way for an "Average Joe" to become a millionaire. Yet, to succeed, Joe must understand the ways to make money with investment property.
In this article we'll walk you through the 5 primary ways to make money as a real estate investor.
The concepts below are simple to understand and put into place. By the end of this article you'll have a clear understanding of how how to make real money with property.
Buying a home for less than market value provides the buyer with 'instant equity'. The buyer "makes money" the very second they take ownership of the home.
Sarah and I had lived in our new home for 6 months when we learned about a foreclosure in my sister's neighborhood.
We loved the idea of living close to family, but hated the idea of moving again. It's such an energy suck.
After touring the home we decided we'd buy it, but only if we could get ourselves a smoking deal. Otherwise, as much as we love my sister and her family, it wasn't worth moving AGAIN!!!
The home's list price was at market value -- $375,000. But, it had a lot of cosmetic issues that made the home ugly. Thus, undesireable to most buyers looking for an updated property.
It needed about $5,000 of work -- interior paint, carpet cleaning, new shutters, some landscaping, refinishing of wood trim, etc.
We submitted a low-ball offer for $258,000 to see what would happen. We also directed the bank to keep our offer as a backup for as long as the home was available for sale.
The bank immediately countered back at $350,000. We weren't interested in purchasing the home at that price so we ignored the email and moved on.
A month later, out of the blue, we received an email from the bank accepting our original offer of $258,000. We immediately finalized the purchase agreement, and 6 weeks later moved into our brand new home.
In the example above, we purchased a $375,000 home for $258,000. That's $112,000 in instant equity after spending $5,000 on cosmetic improvements.
Think about this...it took us 3 hours to make $112,000. 1 hour to tour the home. 1 hour to write up the offer. 1 hour at the closing table. That's an hourly rate of $37,000+. 😉
Instant equity is 1 of 2 strict criteria we have when buying single-family rental properties. If we can't get instant equity, we will not buy the property.
Rule of Thumb: We will not purchase an investment property without a minimum of 10% instant equity. This gives us an immediate "risk cushion" if something were to go wrong in the future.
Cash flow is the other criteria we have when purchasing a property. If the property doesn't have a clear path to profit, we will not buy it.
In the real estate world they say cash (flow) is king. It is. Without cash flow your investment can't stand on its own. You'll need to subsidize it each month with your wallet. It is not a scalable business. Plus, do you like to lose money every month? We sure don't!
We calculate cash flow as follows:
- Operating Expenses
- Debt (Mortgage) Service
- Capital Expenses
Total annual rent possible. Not actual rent received.
Recurring expenses, including property taxes, insurance, utilities, landscaping, accounting, advertising, etc.
Debt (Mortgage) Service
The mortgage payment. The principal and interest paid to the bank.
Vacancies & Unpaids
Vacancies happen when homes are empty (vacant). Unpaids are rents that go uncollected due to non-paying tenants. We prefer a conservative approach so we calculate this as 8% of gross rents.
Capital Expenditures (CapEx)
Large one-time expenses, such as a new roof, appliances, air conditioner, boiler, plumbing, electrical, etc. We calculate this as 8% of gross rents.
Total Gross Rents: $30,000
The following expenses are the tenant's responsibility:
*We self manage our properties so there are no property management fees.
Total Operating Expenses: $5,720/year
Debt Service (the mortgage!)
Total Debt Service: $10,308/year
Vacancies & Unpaids
Total Vacancy & Unpaids: $1,920/year
Capital Expenditures (CapEx)
Total Capital Expenditures: $1,920/year
$30,000 Gross Rents
- $5,720 Operating Expenses
- $10,308 Debt Service
- $1,920 Vacancies
- $1,920 CapEx
$10,132 in annual cash flow. That's $844 in cash flow per month.
Rule of Thumb: We aim to cash flow at least $300/month for a single family home. Some investors target $100/month or less. Pick a number that makes you comfortable.
When making a mortgage payment to the bank, part of the payment applies toward the principal and part toward interest.
The bank -- because they exist to make money -- structures mortgages in their favor. Surprise, surprise!
At the beginning of a mortgage, the majority of the monthly payment applies to interest. As the loan ages, the majority of the monthly payment applies to the principal.
The banks like this structure because it ensures that they make most of their profit (the interest) at the beginning of a loan. Whether a homeowner stays in their home for 5 years or 30 years makes little difference to the bank. They've already turned a profit on the loan.
Regardless, with each mortgage payment, the amount owed to the bank (the principal) decreases. This results in increased equity every single month.
Let's continue looking at our rental property. We went with a $200,000 30-year mortgage at a 5% interest rate.
Over 30 years, a homeowner will pay a total of $386,511. $200,000 in principal payments, and $186,511 in interest payments.
Let's focus on the principal paydown by year. Remember, for a cash flowing property, the tenant is paying the mortgage for you.
Historically, property has increased in value (appreciated) somewhere between 3-5% per year.
Appreciation can be volatile in the short term, but over long periods of time it is safe to assume at least 3%. 3% is the number we use in our analysis.
To demonstrate the power of appreciation, let's use the same $200,000 property appreciating at 3% per year.
Uncle Sam & the IRS love real estate investors. This love results in tax laws allowing real estate investors to pay very little tax on their profits -- preferential treatment at its finest.
It's a lot to cover so we won't do it here. If you're interested in doing a deeper dive not only into tax benefits, but also real estate investing as a whole.I recommend you sign up for our free real estate course
Let's put everything we've learned together to demonstrate the power of real estate. We'll continue using our example investment property, looking at a 10-year window.
$30,000 Instant Equity
+ $101,310 Ten Years of Cash Flow
+ $37,311 Ten Years of Principle Paydown
+ $68,783 Appreciation
$237,404 (or $23,740 per year)!!!
Crazy, isn't it? It's not so difficult to believe that a savvy janitor can become a millionaire using real estate. And do so in a relatively short amount of time.
Things To Remember:
Biographical Info goes here
Please log in again. The login page will open in a new window. After logging in you can close it and return to this page.