There are four main ways that a person can make money through real estate when investing in rental properties. These include cash flow, appreciation, taxes, and equity.
Cash Flow
Cash flow is the amount of money that is moving in and out of your real estate business. Cash inflows into the business come from the rents that a property owner receives from tenants. Cash outflows are all the expenses that a property owner pays on their rentals. These include, but are not limited to the mortgage payment, repairs and maintenance, utilities, etc. For the real estate business to operate, the property owner must ensure that cash flow remains positive.
As an example, if one has rents of $1,650 and a mortgage of $1,000 with monthly expenses of $200, then the net cash flow on the property is $1,650 – $1,000 – $200 for a net cash flow before taxes of $450.
Appreciation
Appreciation on a property is the increase in value of a property over time. Appreciation may occur due to factors such as inflation, increased job opportunities, or overall development in a town. A property owner can also increase the property value by making improvements to the home. These include upgrading the bathrooms, kitchen, replacing windows, or adding a deck and patio. Of the four ways of making money through rental real estate, this is the one that I pay attention to the least as it can be highly speculative.
Taxes
Taxes on a rental property are affected by the expenses that one pays, but they can be a huge benefit to a property owner. With a rental property, the investor can take deductions on the mortgage interest, costs of cleaning and maintaining the property, property manager fees, advertising, HOA fees, property taxes, and legal and professional services. In addition, there are expenses such as depreciation that the property owner can deduct against the property.
Depreciation is defined as the reduction in value of a property over time due to wear and tear. A homeowner is unable to take advantage of this benefit when doing their taxes. An investor, however, may deduct depreciation against their taxes. The unique aspect about depreciation is that even though a property may show a positive cash flow, when applying depreciation against the property it can generate a tax loss.
For best results, it is highly advisable to consult with a tax professional when determining which items are deductible for tax purposes.
Equity
Equity is the difference between the value of a property and the amount owed on the property. The best way to increase the equity in the property is to pay down the loan on the property. The advantage that real estate owners have is that they can use the rent that they receive to pay down the property. Factors that will impact the amount that one pays on the property include the interest rate, amount borrowed, demand for the property, and the down payment on the property. If the mortgage monthly payment is less than the rents received, then the owner can pay down their equity.
There are ways to increase equity in the property. The first is to use the net cash flow to pay the property faster. The second way is to make extra mortgage payments and overpay on the property. One can also add value to the property by upgrading the bathrooms, kitchen, or adding a deck and patio.