When it comes to making money in real estate investing, there are really only a handful of ways to do it. This brief overview was designed to help you understand the basics of real estate and how successful real estate investors work in order to maximize their profits.
The Three Ways to Make Money from Real EstateThe three primary ways investors make money from real estate are:
- An increase in the property value
- Rental income collected by leasing out the property to tenants
- Profits generated from business activity that depends upon the real estate
For the most part, that is it. Of course, there are always special ways to make money but these three items probably account for 99% of the money made in the real estate industry.
1. Making Money from an Increase In the Property Value
The truth is, property values do not always increase, which has been painfully evident over the past few years. In fact, property values hardly beat inflation in many cases. If you own a $500,000 piece of real estate and inflation is 3%, your property might sell for $515,000 but you aren't any richer than you were last year. That is, you can still buy the same amount of milk, bread, cheese, oil, gasoline, and other commodities (true, cheese may be down this year and gasoline up, but your standard of living would remain roughly the same). The reason? The $15,000 gain wasn't real.
This happens because the government has to create money when it spends more than it takes in through taxes. This results in each existing dollar losing value and becoming worth less than it was in the past.
One of the ways that the savviest real estate investors can make money in real estate is to take advantage of a situation that seems to crop up every few decades: When the rate of inflation is projected to exceed the current rate of long-term debt, you might find people willing to gamble by acquiring properties, borrowing money to finance the purchase, and then waiting for inflation to increase. That way, they can pay off the mortgages with dollars that are worth far less. This represents a transfer from savers to debtors. You saw a lot of real estate investors making money this way in the 1970's and early 1980's as inflation began to spiral out of control before Paul Volker took a 2x4 to its back and brought it under control by drastically raising interest rates.
2. Making Money from Rental Income
Making money from collecting rents is so simple that every six year old who has ever played a game of Monopoly understands how it works! If you own a house, apartment building, office building, hotel, or any other real estate investment, you can charge people rent in exchange for allowing them to use the property or facility.
The good news is, there is a simple tool that can be useful in your quest for making money in real estate: It is a special financial ratio called the cap rate, which is short for "capitalization rate". If a property earns $100,000 per year and sells for $1,000,000, you would divide the earnings ($100,000) by the price tag ($1,000,000) and get 0.1, or 10%. That means the cap rate of the property is 10%, or that you would earn an expected 10% on your investment if you paid for the real estate entirely in cash and no debt.
3. Making Money from Real Estate Business Operations
The final way of making money from real estate investments involves special services and business activities. If you own a hotel, you might sell on-demand movies to your guests. If you own an office building, you might make money from vending machines and parking garages. If you own a car wash, you might make money from time-controlled vacuum cleaners. These types of investments almost always require sub-specialty knowledge; e.g., there are men and women who spend their entire career specializing in designing, building, owning and operating car washes. For those who rise to the top of their field and understand the intricacies of a particular market, the opportunity to make money can be endless.
More Information About Making Money In Real Estate
For more information about how to make money in real estate, read The Complete Beginner's Guide to Real Estate Investing.