Intro to Commercial Real Estate Part III

The Four Ways to Make Money in Real Estate 

By Jessica Garcia

Real estate has always been one of the more popular asset classes for investors.  It is appealing to investors for a number of reasons; but primarily because it’s tangible and we all have an intuitive understanding of what real estate is because we interact with it on a daily basis.   

If you ask the average investor how someone can make money in real estate, they’ll more than likely respond with either cash flow or appreciation, but there are actually four ways for real estate investors to make money in any deal.  And while not every investment will provide each of the four in equal measure, every income property has the potential to provide you with as many as four different types of returns. 

We define and explain each of these four returns in detail.

Cash Flow

When you buy a real estate investment property you should remember you are really buying it’s income stream, or cash flow. Cash flow is basically what remains after you subtract your monthly expenses from your income. 

• Cash in - Cash out

  • Example: Total cash inflow for the month is $10,000 - monthly expenses of $8,000 = $2,000 (positive cash flow)

• Positive cash flow: When you earned more money than you spent 

• Negative cash flow: When you have spent more money than you have earned

Appreciation

Appreciation is the benefit you receive when you sell your property for greater than what you paid. And for the most part, real estate tends to appreciate over time. Appreciation is driven by a number of factors, but the core driver is increased demand for the property, or the area around the property. 

• Appreciation = sale price - purchase price

Loan Amortization 

Loan amortization is when the amount you owe on your mortgage decreases as payments are made. And as your debt decreases, your equity increases.  So your tenants are effectively buying your property for you over time. 

• Loan Amortization = debt service - interest paid

Tax Shelter

Owning real estate comes with great tax benefits. If you have an investment property you are allowed to deduct depreciation of the building and any additional capital investments which will reduce your taxable income. So, even though your investment may be increasing in value over time the IRS allows you to deduct the useful life of your property over time. You can also shelter cash flow using like-kind exchanges.

• 1031 exchange: may allow you to defer taxes on sale indefinitely

(Remember to always consult with a tax advisor to ensure you are receiving full tax benefits.)

Stay tuned for our 4th chapter to this series next week!