Investing in Real Estate and Making Money

When it comes to making money through real estate investing, there are just a few options. Though the concepts are simple to grasp, don’t be tricked into thinking they are simple to apply and execute. Understanding the fundamentals of real estate can assist investors in working to maximize their profits. When approached appropriately, real estate adds another asset class to an investor’s portfolio, promotes diversification, and can decrease risks.

There are three basic ways for investors to profit from real estate:

1. An increase in the value of the real estate
2. Rental income derived from renting out the home to tenants
3. Profits derived from real estate-related commercial activities

Of course, there are other methods to benefit directly or indirectly from real estate investing, such as learning to specialize in more obscure sectors such as tax lien certificates. However, the three factors described above account for the great bulk of passive income (and eventual fortunes) made in the real estate market. 

Real Estate Increase in Property Value

First and foremost, you must understand that property values do not always rise. This lack of asset growth can be painfully visible during periods such as the late 1980s and early 1990s, as well as the years 2007-2009 when the real estate market crashed. In reality, in many circumstances, property values rarely outperform inflation—the growth in an economy’s average prices.

For example, if you own a $500,000 home and inflation is 3%, your home may sell for $515,000 ($500,000 x 1.03%), but you are no richer than you were last year. That is, you can continue to purchase the same quantity of milk, bread, cheese, oil, fuel, and other goods (true, cheese may be down this year and gasoline up, but your standard of living would remain roughly the same). The reason for this is that the $15,000 gain was fictitious. Because the increase was related to overall inflation, it was only nominal and had no practical impact.

Inflation and Real Estate Investing

When there is inflation, the purchasing power of a dollar decreases.

It occurs when the government is forced to create—print—money when it spends more than it receives in taxes. All else being equal, this results in each existing dollar losing value over time and becoming worth less than it was previously.

One of the smartest real estate investors may make money in real estate by taking advantage of a situation that appears every few decades. They do this when inflation is expected to exceed the existing long-term debt interest rate. People may be willing to gamble during these periods by purchasing homes, borrowing money to finance the purchase, and then waiting for inflation to rise. Karaikudi good place to invest in property.

As inflation rises, these investors will be able to pay down their mortgages with dollars worth far less. This scenario depicts a shift of wealth from savers to debtors. In the 1970s and early 1980s, you saw a lot of real estate speculators making money this way.

Cyclically Adjusted Cap Rate Purchases

The key is to acquire when cyclically adjusted cap rates (the rate of return on a real estate investment) are appealing. You buy when you believe there is a precise reason why a specific piece of real estate will be worth more than the current cap rate implies it should be. 9

Real estate developers, for example, can examine a project or development, the economic situation surrounding that project, or the property’s pricing and forecast future rental income to support the existing valuation. Based on the current conditions around the development, the current valuation may appear to be too pricey. These investors, on the other hand, can see future profitability because they understand economics, market variables, and consumers.

You may have witnessed the transformation of a run-down old hotel on a prime piece of land into a lively shopping area with office buildings generating substantial rents for the owner. Regardless of what you tell yourself if you don’t have those cash flows, net present value, you’re speculating to some extent. If you’re using debt to finance the transaction, you’ll need significant inflation in the nominal currency to bail you out. You may potentially rely on a low-probability event to work in your favor.

Rental as a Real Estate Investment

Making money by collecting rent is so straightforward that any 6-year-old who has ever played Monopoly understands the fundamentals on a visceral level. You can charge people rent to utilize your house, apartment building, business building, hotel, or any other real estate investment.

Of course, simple and easy are not synonymous. You may have to deal with everything from malfunctioning toilets to renters running meth labs if you own apartment complexes or rental houses. If you own strip malls or office buildings, you may have to deal with the bankruptcy of a business that leased from you. If you own industrial warehouses, you may face environmental inquiries as a result of the tenants that exploited your property. Theft may be a problem if you own storage units. Rental real estate investments are not the type of investments that can be made over the phone and expect things to go smoothly.

Using Cap Rate to Compare Investments

The good news is that there are tools available to help you compare potential real estate investments. One of these is a particular financial measure known as the capitalization rate, which will be invaluable to you in your quest to make money from real estate (cap rate). The rate of return on a commercial real estate investment is represented by cap rates. 10 It is based on the net income generated by the property.

If a property earns $100,000 per year and sells for $1,000,000, the profits ($100,000) are divided by the price ($1,000,000), yielding 0.1, or 10%. That indicates the property’s cap rate is 10%, meaning that you would expect to make 10% on your investment if you bought the property totally in cash with no debt.

In the same way that a stock is eventually only worth the net present value of its discounted cash flows, a piece of real estate is ultimately worth a mixture of:

• The utility generated by the property for its owner
• The net current cash flows generated in relation to the purchase price

Rental Income as a Margin of Safety

Rental income can provide a cushion of protection amid economic downturns or breakdowns. Certain sorts of real estate investments may be more appropriate for this reason. Leases and rents can provide a relatively secure source of income.

To return to our earlier discussion of the difficulties of producing money from real estate, office buildings can serve as an example. Typically, these properties have multi-year leases. If you buy one at the right price, at the right time, and with the proper tenant and lease maturity, you might be able to avoid a real estate crash. You would get above-average rental checks that the companies leasing from you are still required to provide owing to the lease agreement they signed, even if lower rates are available elsewhere. If you get it wrong, you could be stuck with subpar results even after the market has recovered.

Money From Real Estate Business Operations

The third approach to profit from real estate investments is through customized services and company activities. You could sell on-demand movies to your hotel guests if you operate a hotel. If you own an office building, vending machines and parking garages may generate revenue. Time-controlled vacuum cleaners could make you money if you own a car wash.

These investments nearly always necessitate sub-specialty expertise. Some people, for example, devote their entire career to planning, developing, owning, and operating car washes. The chance to gain money can be limitless for individuals that reach the top of their field and understand the complexities of a specific market.

Other Real Estate Investment Ideas

Still, there are other real estate investing prospects. You can put your money into real estate investment trusts (REITs). Publicly traded REITs issue shares and are traded on an exchange, whereas privately held or non-traded REITs are not traded on any exchange. All REITs will concentrate on specific segments of the real estate industry, such as nursing homes or shopping malls. There are also various exchange-traded funds (ETFs) and mutual funds that invest in REITs and other real-estate investments aimed at the real estate investor.