6 Ways Rental Property Investing Makes You Money

So, how do you know which property to invest in and how do you know if a property is going to make you money or not?  That is the most important question you can ask yourself when you are considering a deal.

I absolutely LOVE rental property investing!

To find the value of a deal, you only need to know basic arithmetic to calculate the rate of return.  You know, the math you learned in elementary school. The trick is to use the formulas to put together to value the deal.

When I started investing, the only thing I looked for was if the property gave a positive cash flow each month or not.  I am glad that I continued to buy real estate even though I only saw one way to make money from them. Now, after years of investing, I have gained so much value and increased my net worth because of the other ways to make money.

One property that I own has appreciated 100% from the time I bought it which was 4 years ago.  Amazing!

Talk about a great surprise!

Before you make an offer on a property, you should calculate your total return by using the formulas I have here in this post.  This is the only way to make an intelligent decision as to whether or not their is a good enough return on your money to consider the property worth buying.

The best way to evaluate the return to see if the property is worth buying is by analyzing the cash on cash return for the property. Basically if you invest X amount of dollars and can’t return at least 30% in the first year then you should not make the deal.

I like to use the FREE Rental Property Investment Calculator since it has all the formulas set up for me.  All I have to do is put in a few numbers and the calculator does all the work for me.

The average rate of return for the stock market is at best at 10% return every year.  A 30% return on your money in rental properties seems like it would be extremely high compared to the 10% from the stock market. Actually, a 30% return in real estate is very low and I may even pass on a deal with only 30% return.  I have seen returns as much as 100%, 200%, and even 500% with my rental properties.

The goal of 30% is there to help you in two ways. 1. So you can make a good return on your money. 2. To protect you from any errors that you may have done when you evaluated the property and gives you some room to still make money.

6 Ways Rental Property Investing Makes You Money

1. NET PROFIT VALUATION – CASH FLOW

Step 1 –     Calculate gross rents, both yearly and monthly.

Step 2 –     Add up in total all variable expenses, both yearly and monthly.

Step 3 –     Add up in total yearly mortgage payments.

Step 4 –     Deduct variable expenses and mortgage payments from your gross rents.

Step 5 –     Take your net figure and divide it by your down payment. This will give you a percentage figure that will give you a rate of return on your invested cash.

Examples:
Earned / Down Payment = Return On Investment
$500     / $2,000   = 25%   ROI
$4,000 / $2,000   = 200% ROI
$5,000 / $2,000   = 250% ROI

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6 Ways to Make Money Example:

In a single family home with a $10,000 down payment the analysis would look like this:

Rent:                                     Monthly                              Yearly
                                   Total:   $1,100                                   $13,200

Expenses:                           Monthly                              Yearly
Taxes:                                    $100                                       $1,200
Insurance:                             $50                                          $600
Water and Sewer:            Tenants Pay
Utilities:                               Tenants Pay
Advertising:                          $10                                          $120
Vacancy 5%:                         $55                                          $660
Total:                                    $215                                       $2,580

Mortgage Debt:                Monthly                              Yearly
1^st Mortgage:                     $538                                       $6,456
2^nd Mortgage:                         $0                                              $0
                                Total:     $538                                       $6,456

                                               Monthly                              Yearly
Gross Rents                                  $1,100                                  $13,200
– Expenses                                        $215                                   $2,580
– Mortgage Debt                           $538                                   $6,456
NET CASH FLOW:                   $347                                $4,164

Since your total investment you put in the deal was the $10,000 down payment on the property, take the net yearly cash flow of $4,164, and divide it by the total investment of $10,000. $4,164 / $10,000 = 0.4164 = 42% return on your money in the first year! Imagine if you only put down $5,000 on the property your return would be 83% in the first year! Try to get that in the stock market!

 

2. EQUITY CAPTURE

Remember that you make your money when you buy the property and you realize your money when you sell it. This is what equity capture is all about. You do not want to buy a property for market rate because you do not make any money to buy the property.

Market Value:                                                                                                   $125,000
Purchase Price:                                                                                               -$100,000
NET EQUITY CAPTURE                                                                       $25,000

To calculate the return on your investment (ROI) on the equity capture you divide the equity capture amount by the total investment to get your return. $25,000 / $10,000 = 250% ROI!

 

3. FORCED APPRECIATION

As investors, we do not want to buy the best and prettiest house on the street. It is best to buy properties that you can put some work into to make the value of the property to go up. Here are some things to look for:

1. Exterior and interior paint needed
2. Front yard landscaping
3. New carpet or flooring
4. New fixtures for lighting and plumbing
5. New baseboards and trim.

These are relatively inexpensive repairs that you can do to make the value of the property go up.

It is not uncommon to spend $10,000 fixing up the property and force the appreciation up by $25,000 to $30,000.

Revised appraised value of property:                                                       $155,000
Original purchase price of the property:                                                -$100,000
Cost of improvements:                                                                                   -$8,000
FORCED APPRECIATION:                                                                $47,000

To calculate the return on your investment (ROI) on the appreciation you divide the forced appreciation amount by the total investment to get your return. $47,000 / $10,000 = 470% ROI!

 

4. MARKET APPRECIATION

If you know your market, you will be able to estimate how much specific improvements will increase the value of your property. Appreciation on your property turns into cash profit when you sell or refinance the property.

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5. EQUITY BUILDUP

As rents pay down the mortgage balance, the equity increase is considered profit. The equity is only on paper until you sell or refinance the property.

Purchase Price:                                                               $100,000
down payment:                                                                -$10,000
Initial loan amount:                                                        $90,000
amount applied to principal 1 year of payments:          -$800
NEW PRINCIPAL BALANCE:                             $89,200

To calculate the equity buildup ROI divide the amount of equity by the initial investment of $10,000 for the down payment. $800 / $10,000 = 8% ROI

 

6.TAX ADVANTAGES

With investing in real estate, you get many tax advantages because the laws are written to benefit those who own real estate. You will be able to offset most, if not all, of your income for tax purposes because of depreciation. The IRS tax law states that real estate goes down in value after you purchase it even though we know that properties, given enough time, will always appreciate in value.

Check out my article on the top 15 Tax Deductions for your Real Estate Business

Write-Off Business Expenses

All your business expense you incur in your business, you can use that to offset how much of your income is taxed. Here is a small list of a few items you can write-off:

• Cell phone
• Mileage traveled
• Home office
• Electronics used for your business
• Home internet

Depreciation

The IRS lets you depreciate the value of your property over 27 years and that depreciation offsets your income from the property.

1031 Exchange

How much of the tax advantage you will get from depreciation depends on your tax bracket and your sources of income. It’s generally around 5 to 15% ROI from this tax advantage on your initial investment.

 

RECAP OF THE EVALUATION AND ROI

Net Cash Flow                                                                                     42%
Equity Capture                                                                                 250%
Forced Appreciation                                                                      470%
Market Appreciation
Equity Buildup                                                                                      8%
Tax Advantage (average estimate)                                              10%
1^st YEAR TOTAL RATE OF RETURN                                        780%

 

Total of 780% ROI on your investment in one year! Try to get that in the stock market, bonds, treasury bills, or any other investment. Hopefully you can see that you can make tremendous amounts of money in rental properties and all it takes is the knowledge to do so and the drive to put into action.

These numbers can get a little confusing but I encourage you to look this section over again on how rental properties can make you money six different ways.

If you have any comments or questions, please leave a comment!  I'd love to hear from you!

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