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Real estate investing is a strategic way to grow your investment portfolio over time. But how does it work exactly?
There are several different ways one can invest in real estate – buying and developing land, owning multi-family buildings such as apartments, flipping homes, vacation rentals, and of course, buying a property and then renting it out, aka, a long-term rental.
Long-term rentals are a great way to build cash flow in addition to building equity. For example, if an investor buys a home and has a mortgage and other expenses of $2,400 per month, the investor may be looking for a monthly income of $2,600 or more to cover the monthly expenses plus a bit more for maintenance and profit OR they may be looking for a property that returns much more than that in terms of monthly cash flow. Each investor and their goals are different.
It is important to note that time is the best resource that savvy investors have. Time usually results in greater monthly cash flow profits and greater equity. Let’s look at an example:
Purchase Property info
(30 year fixed at 5%)
|Other monthly expenses|
(property taxes, insurance, water/sewer, garbage)
|Property Management Fee||$320|
|TOTAL MONTHLY FEES||$3,067|
Even if the max rent this investor can get during the first year is $3,200 per month, the savvy investor isn’t worried as that can quickly change. Here is why:
- Rent rates can increase. A 5% annual rent increase can quickly increase that $3,200 per month to $3,890 per month in five years.
- Expenses can increase. Property taxes, utilities, maintenance, etc can all increase annually, but what is likely the largest monthly expense – the mortgage – will stay the same if the investor has chosen a fixed-rate mortgage.
Projected Net Profits
|Projected Profit Year 1||$1,592.56|
|Projected Profit Year 5||$8,446.95|
|Projected Profit Year 10||$19,241.80|
|Projected Profit Year 20||$51,074.92|
In this example, we are assuming that expenses are increasing 2% per year.
Furthermore, when the time comes to sell the investment, the investor will have all of that appreciation to bank on. With a positive net cash flow per month, the investor will have paid for his or her expenses on the investment and pocketed the profit at the end of the day.
|Equity Year 1||$100,000|
|Equity Year 5||$274,364|
|Equity Year 10||$498,136.49|
|Equity Year 20||$1,153,871.07|
In this example, we are assuming that the property value is increasing 5% per year and all principal and interest payments are made.
It is impressive to see that after 20 years, that $100,000 investment has resulted in over $1.1 million in equity – and our example shows virtually no other cash out-of-pocket (although realistically, appliances will break, the roof will need to be fixed, etc). Additionally, the owner is receiving $51,074.92 per year. That is how to gain financial freedom and REALLY plan for an early retirement!
Of course, this is not a guarantee that each investment will perform as indicated above. There are also risks involved in every type of investment.
There are other benefits too!
Depreciation – as an investor, claiming depreciation on your asset can be a tax strategy to offset income…on paper.
Investment income is different than employment income – Social Security and Medicare expenses can take a bite out of your employment income. Not so for investment income.
Investment income is different than retail or service income – In Washington State anyway, long-term rental income is not subject to B&O tax like other types of income.
Intrigued? If you have been wondering how real estate investors do it and would like to learn more, please give us a call. We have calculators that make it easy to run scenarios, look at formulas such as Cap Rates, Gross Rent Multipliers, Return on Investment and more (and explain what these all mean).