How does the real estate industry work?
Compared to other forms of investments, real estate has remained one of the sought-after investments by first-time and established investors. Generally, real estate investing has several essential benefits, such as steady income, long-term financial security, complete control over your real estate investment strategies, and the ability to create wealth.
But like other investment assets, investing in properties comes with risk, which means you can lose money over time, especially when the investment doesn’t pay off. Because of this, proper planning and research should be done to minimize the risks and maximize profits.
You can start by knowing some ways to invest in real estate. These can include:
- Real estate crowdfunding
- Buying rental properties
Crowdfunding is different from buying rental properties since the former is a way to invest in real estate passively. Meanwhile, the latter requires investors to take an active role in the investment process.
When you invest in crowdfunding platforms for real estate, you provide the funds along with the other investors’ money for the investment. The platform will then use the money to start the real estate investment, which involves finding the right property, buying it, and managing it after being rented to the tenants.
On the other hand, when you purchase rental properties, you require time and effort since you have to find the property, negotiate the sale, and make it ready for rentals.
In this article, we will focus solely on rental properties.
This involves buying a house that you rent out to people looking for somewhere to live. Before we go through the maths behind how much you can make let’s get us both on the same page as to the fundamentals of owning rentals and why they’re so powerful.
There are four main factors to wealth generation in real estate that make owning rentals such a lucrative opportunity.
Property Cash Flow
Cash flow is the extra money every month that a property produces in profit. This is income minus expenses. The key to this is understanding expenses because they’re not always straightforward.
Real Estate Appreciation
Appreciation in this context is the concept that real estate value tends to increase over time. Obviously, there are changes in price and large drops like we saw in 2008, but over a long enough time prices will rise as long as you can hold on to your property.
This concept is why cash flow is so important because if you are making more money than the cost of your house you’ll be able to hold your property for the long term.
Home Loan Paydown
Normally, when you buy a piece of real estate you get a loan from a bank which you then pay every month. Over time the loan gets paid down, which means you might start owing $200k but eventually you’ll owe nothing.
Opposite the appreciation, the loan starts high and then tends to drop to nothing (assuming you keep paying).
For the purpose of this article, we’re not going to dive too deep into tax benefits, but in real life the tax benefits are huge. If you make $100k from real estate and your friend made $100k from a job or a business you’ll end up keeping far more of that money.
Now we can get into the calculations of how these wealth generators combined can benefit your financial situation.
Real Estate Wealth Calculations
Let’s say you bought a house for $100k you had to put down 20% which is $20k. This means you’re left with an $80k loan or mortgage as it’s called in real estate. Now, let’s assume as you’re renting this property out you’re receiving $200 profit every month in cash flow.
This is a $2400 profit per year in cash flow. Now you would have had to pay back some of the mortgages of the year so let’s assume you paid back $1500 so the mortgage is now $78,500.
But on the other hand, real estate tends to appreciate by about 3% annually on average so let’s assume your property is now worth $103k.
So let’s do the addition
$3000 – $1500 + $2400 = $3900 that you have added to your net worth at the end of the year. Now it seems that you’re far away from being a millionaire but the cool thing about real estate investing is that this process accelerates with every year.
With your cash flow, you can pay off more and more of the loan faster, while your property keeps appreciating in value at the exact same time. If we take a 10-year look at this we can see that your net worth will increase as follows:
10-Year Real Estate Wealth Creation
This means at the end of 10 years your net worth from holding this property would have increased by $43,392. If you held the property and did the same for another 10 years your net worth increase from the start would now be $198,611.
And now you can see the power of compounding interests.
With your profits, you can use this to acquire new real estate properties and start building your empire. It’s a long steady process, but it is extremely safe and secure unlike other types of investing.
If you are looking to acquire real estate in Adelaide for investment, Fox Real Estate can help you get started today.