There are many ways to make money in real estate.
You can sell a property for more than you bought it.
You can rent the property on long term or short term leases.
You can also offer lease-to-own, use built-up equity for purchasing more properties, refinance mortgage payments, build up your credit etc.
However you must take into account the amount of money spent in taxes, insurance, maintenance, management and buying and selling fees involved in the process.
This is called cash flow.
The key to Making money in real estate is positive cash flow, meaning you take in more than you spend in expenses.
Making money in real estate: Income
Income is money brought in by renters, or money made through various lease agreements.
There is also equity that can be derived from the property, over time, if the value increases above the original purchase price.
If the price increase is real enough, one can get a loan on this value, from the bank or mortgage company (refinance with cash back).
If you use this money foolishly it will just put you farther into debt. However, if you invest this money wisely, like purchasing another property, you may be able to increase your income through this new investment.
Down Payments
The down payment is the amount of money you have to pay to purchase a property. This amount typically ranges from 10 – 30%. The rest can be covered by a loan.
To increase cash flow a larger amount paid up front will lower your mortgage payments.
Mortgage Payments
A mortgage is the amount you own a bank or lending institute that loaned you the money to buy the property. Usually paid through monthly or bi-monthly installments. They can be fixed payments over longer time spans like 20 – 30 year, or in adjustable rate mortgage (arm) and change over a given period say 2-5 years.
You can increase cash flow by making bi-monthly payments, or making the occasional larger payment.
Interest Payments
The interest payments are the amount of money that goes to pay the interest on the loan. The amount you borrow is called the principal, and both are included in the monthly mortgage amount. In the beginning, most of your payment goes into the interest, later in the loan more goes into the actual loan.
So the sooner you pay off the loan the less you pay in interest, and thus make more money in the long run.
Price Paid for the Property
The price includes all the fees and service charges paid during the process of purchasing a property. If you paid cash for a property than you will not have to pay a mortgage, or mandatory insurance, and can save a ton of money. However since many interest payments on loans is tax-deductible it may be better to get a loan depending on your situation.
Remember to not forget charges during the process that may include: Escrow fees, home and termite Inspections, mortgage insurance, home owner insurance, local taxes, listing fees, realtor fees, attorney fees, title searches, past property liens, condo fees, maintenance fees etc.
To increase your cash flow, you can always ask for the seller to agree to pay for these various fees, or adjust your offer accordingly.
Taxes
Taxes on real estate are generally called property tax. The amount is usually derived out of charging a certain percentage of what the property is worth. Each area has a different formula, and some states have extremely high property tax, and can be higher than insurance and management fees combined.
There is also capital gains tax charged on the profit you make after you sell a property it held for more than two years. For a primary residence after two years there is no capital gains tax typically up to 250,000 for single tax filers and 500,000 for married filers.
To increase cash flow make sure you challenge the local governments, typically the counties, “assessed value” of the home, ask for any governmental programs to lower taxes, or any deductions or audits that can be done ie installing energy efficient appliances, switching to gas etc….
Insurance
If you have a loan from a bank, than they will need you to buy and maintain insurance on the property. Usually it involves casualty and general liability like fire, flood, earthquake, tsunami, hurricane, personal injury etc. There is also mortgage insurance, which covers your mortgages if you can’t make the payments.
It often various region to region, and the amount may change on what the property is worth, location, kind of property, and what is required by law. If you paid for the property with cash, than it’s usually left up to your own discretion as to what kind of insurance you need to purchase.
To increase cash flow, make sure you go to as many insurance companies as you can for quotes. Also make sure you don’t have coverage for what you dont need or have redundant insurances (these can be from home policies, credit card offers, etc.)
Management Fees
When you have an investment property someone has to manage it. If you do not know how, or do not live near the property, than you will have to pay for someone to manage the property.
This typically includes hiring someone, or some company to find and keep renters, deal with complaints, find maintenance people for upkeep and repairs, handling paperwork and helping with taxes and insurance. The fee generally ranges from 8 – 15% of the income generated by those paying rent.
To increase cash flow, make sure the manager gets more than one quote for repairs, and doesn’t charge for miscellaneous fees (printing/mailing unnecessary documents, paying for repair quotes etc.)
Maintenance
This basically include everything to keep the property in good shape and rent-able. For residential it runs about 12 – 15%, and for commercial property it can run 18-22% of amount of money brought in each year in income.
Of course this is just an estimated figure and it is itemized out over the life of the property. When you buy a condominium or townhouse there is a monthly fee that all unit owners pay, which covers most of the exterior, landscaping, site work, parking etc.
This is a great way to save on cash flow. Remember to do preventative maintenance every year or so, contact local friends or family for possible recommendations, read repair/replacement quotes in detail to ensure proper material is used, have renters take care of the yard or other simple activities etc.
When it comes to renting a home, who pays for the utilities is up for negotiation. Depending on the location these include: Electric, Gas, Water, Sewer, Communications, and possibly yard and road maintenance fees.
Make sure you don’t pay the utilities if possible. It is human nature to waste what they don’t pay for. Change out to gas or solar appliances, make sure the house is sealed properly, add insulation where necessary etc…
Making money in real estate: In Conclusion:
It may all sound like a lot of work, and it is. Although if you don’t handle stress well, and shy away from complicated transactions, than you might look into another form of investment.
As in every transaction, the above items might not all apply, but most will be a part of the process. If they are, each needs to be included in the decision to purchase real estate as an investment. If you already own a property, than here is what you can do to decide if you are cash flow positive.
If you do not own a property yet, but want to, than you have to try to find out what each may cost you. You can do this by researching history of the area, how much rent is nearby, what kind of utility costs there are, how are property taxes charged, what kind of loans are available, etc.
To find out if a property has good cash flow, just add up all the items above in an expense column, and minus the total from how much the property brings in over the year.
This figure will give you a good idea on how the property is as an investment or on which areas you can change to make the property a good investment (typically by trying to negotiate lower taxes, cheaper insurance, lower maintenance fees etc.)
Remember that it’s best to run these figures out over a time, say at least 3-5 years. You can also check to see what other similar properties are selling for, and see if the value is increasing or decreasing. This way you can get a feel for how much the property is making, or loosing, and whether the property has a chance to increase in value over the time you want to keep it.
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