How You Make Money In Real EstateBy Andrew Beattie | Updated February 23, 2017 — 10:45 AM EST SHARE Whether you're curious about the investment potential of real estate or simply sick of infomercials promising millions of dollars in returns from a new and obscure way of investing in real estate, it is worth learning how wealth is created through real estate. (For more information on buying a home, see: A Guide to Buying a House in the U.S.) We're not looking at strategies for how to profit from real estate. Instead, this article will focus on the basic ways that money is made through real estate. And, fortunately for us, these haven't changed in centuries, no matter what kind of gloss the gurus of the moment try to put on it. Tutorial: Exploring Real Estate Investments Appreciation The most common source of real estate profit is the appreciation — the increase in the value — of the property in question. This is achieved in different ways for different types of real estate. And, most importantly, it is only realized through selling or refinancing. If you are considering refinancing, then use our mortgage calculator to calculate current refinance rates. Mortgage Rates Sort by APR SPONSORED 4.500% Rate4.548% APR Monthly Payment$1,267 NEXT NMLS#: 3030 | 30-Year Fixed | Fee's In APR: $1,424 | Points 0.250 SPONSORED 4.500% Rate4.548% APR Monthly Payment$1,267 NEXT NMLS#: 3030 | 30-Year Fixed | Fee's In APR: $1,424 | Points 0.250 << 1 2 3 >> Data provided by Informa Research Services. Payments do not include amounts for taxes and insurance premiums. The actual payment obligation will be greater if taxes and insurance are included. Click here for more information on rates and product details. Raw Land The most obvious source of appreciation for undeveloped land is, of course, developing it. As cities expand, land outside the limits becomes more and more valuable because of the potential for it to be purchased by developers. Then developers build houses that raise that value even further. Appreciation in land can also come from discoveries of valuable minerals or materials, provided that the buyer holds the rights. An extreme example of this would be striking oil, but appreciation can also come from gravel deposits, trees and so on. Residential Property When looking at residential properties, location is often the biggest factor in appreciation. As the neighborhood around a home evolves, adding transit routes, schools, shopping centers, playgrounds and so on, the value climbs. Of course, this trend can also work in reverse, with home values falling as a neighborhood decays. Home improvements can also spur appreciation, and this is something a property owner can directly control. Putting in a new bathroom, upgrading to a heated garage and remodeling to an open concept kitchen are just some of the ways a property owner may try to increase the value of a home. Many of these techniques have been refined to high-return fixes by property flippers who specialize in adding value to a home in a short time. Commercial Property Commercial property gains value for the same reasons as the previous two types: location, development, and improvements. The best commercial properties are in demand, and that drives the price up on them. (For related reading, see 7 Steps To A Hot Commercial Real Estate Deal.) The Role of Inflation in Appreciation Of course, there is one major factor we skipped in our summary - the economic impact of inflation. A 10% inflation of the dollar means that your dollar can only buy about 90% of the same good the following year, and that includes property. If a piece of land was worth $100,000 in 1970, and it sat dormant, undeveloped and unloved, it would still be worth many times more today. Because of runaway inflation throughout the '70s and a steady pace since, it would likely take over $560,000 to purchase that land today - assuming $100,000 was fair market value at the time and all other factors remained constant. So, inflation alone can cause appreciation in real estate, but it is a bit of a Pyrrhic victory. Even though you may get five times the money due to inflation, many other goods cost five times as much to buy now. (Learn more in 5 Tales Of Out-Of-Control Inflation.) Income Generally referred to as rent, income - or regular payments - from real estate can come in many forms. Raw Land Income Depending on your rights to the land, companies may pay you royalties for any discoveries or regular payments for any structures they add. These include pump jacks, pipelines, gravel pits, access roads, cell towers and so on. Raw land can also be rented for production, usually agricultural production. Residential Property Income Although it is possible that you may earn income from the installation of a cell tower or other structure, the vast majority of residential property income comes in the form of basic rent. Your tenants pay a fixed amount per month — and this will go up with inflation and demand - and you take out your costs from it and claim the remaining portion as rental income. While it is true that you will get an insurance payout if your tenants burn down the place, the payout only covers the cost of replacing what is lost and is not income in a real sense. Commercial Property Income Commercial properties can produce income from the aforementioned sources - with basic rent again being the most common - but can also add one more in the form of option income. Many commercial tenants will pay fees for contractual options like the right of first refusal on the office next door. These are essentially options that tenants pay a premium to hold, whether they exercise them or not. Options income is sometimes used for raw land and even residential property, but they are far from common. What About REITs or MICs? Real estate investment trusts (REIT) and Mortgage Investment Corporations (MIC) are generally considered to be great ways of getting income from real estate. This is true, but only in the sense that real estate is the underlying security. With a REIT, the owner of multiple commercial properties sells shares to investors - usually to fund the purchase of more properties - and then passes on the rental income in the form of distribution. The REIT is the landlord for the tenants (who pay rent), but the owners of the REIT get the income once the expenses of running the buildings and the REIT are taken out. MICs are even a further step removed, as they invest in private mortgages rather than the underlying properties. MICs are different from MBSs in that they hold entire mortgages and pass on the interest from payments to investors, rather than securitizing the interest streams independent of the original mortgage. Still, they are not so much real estate investments as they are debt investments, and thus outside of our area of interest. (Learn more in How To Assess A REIT.) Smoke and Mirrors Similar to securities with real estate underlying the investment, most of the alternative "blow your mind with super fantastic return" methods are merely a layer on top of these two basic streams of income. For example, there are informal residential real estate options where you pay a fee to have the right to buy a house at a given time, say after a month, for an agreed upon price. Then, you find investors who will pay more than your option price for the property. In this case, the premium you get is essentially a finder's fee for matching a person looking for an investment with a person looking to sell - no different than a real estate agent. Although this is income, it doesn't come from buying (i.e. holding the deed to) a piece of real estate. Similarly, no money down or OPM deals are simply the financing aspect of the deal - it doesn't change how the buyer is planning to make money in the long run. The Bottom Line If someone is trying to sell you on a new way to make money in real estate other than buying low and selling high or collecting rent, they're probably trying to sell you on the process of real estate investing, rather than a new mechanism for making profits. Whether the process is worth it or not is up to you, but know that it doesn't change how the money will be made (or lost) in the end. RELATED ARTICLES
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If you have the option, owning assets that produce income is a better financial strategy than owning assets that generate expenses. If you own a house or apartment for your own residence, for example, you need to pay for maintenance, repairs, taxes, mortgage interest, landscaping, utilities, or a homeowner association fee that covers some of these expenses. If, however, you own a house or apartment available for renting or lease, you can generate income with the property, and in some cases, end up with positive cash flow after all those expenses are paid for.
Being a landlord is a viable vocation; after all, landlords exist for every rental tenant, and they often thrive financially. Sasha, a former writer for Consumerism Commentary, owns several properties. She shared tips for buying a rental property for prospective landlords based on her own experiences. Succeeding in the business of rental properties requires a certain set of skills and desires, and making a living isn’t always as easy as others would lead you to believe. If you want to earn a living, for example the equivalent of a $50,000 salary, you’ll need to profit more than $4,000 per month. That’s a lot of pressure. Consider these questions and tips before you decide to get into the rental property business to determine if you have what it takes to be a landlord. Do you like “doing it yourself?” If you’re a handy person who likes doing your own work around the house — light plumbing, perhaps some construction, yard work, and so on — you might be a good candidate for becoming a landlord. If you’re just starting out, it may be too expensive to handle outside contractors if you expect to turn your rental income into profit. Doing the work yourself saves money. Do you know the right people? If you plan to expand your property portfolio beyond one or two locations — and if you want to earn a living, you’ll likely need to expand quickly — you’ll reach a point where you can’t handle all the work yourself. You’ll need to call in trusted contractors, and if you have personal relationships with contractors, you’re in a better position to negotiate discounts and enhance your overall profit. These relationships take time to build, and it takes time to find the best people to hire for the work. If you’re able to begin your adventure as a landlord with these relationships already formed, then you’ll be in a much better position. The same is true about real estate agents. If you have connections in this business, you will have better access to potential tenants, reducing your advertising costs. Word of mouth is incredibly important, and knowing agents can remove some obstacles before you even get started. Can you handle the 24-hour responsibilities? Hiring a company to manage your properties is an expense that cuts into your profit. Depending on the location, you may be able to afford this from just your rental income. If that’s the case, work with a property management company who will answer the phone at any hour to fix any household problems that arise. Otherwise, be prepared for calls in the middle of the night. If you’re starting your adventure with rental properties while working at another job, you will find yourself with competing priorities often. Do you like dealing with people? Some tenants can be difficult, and in most states, tenants have legal rights that level the playing field in disputes. If you’re able to screen tenants well and have a choice of potential residents, you can carefully choose who will be living in your house or apartment. If, however, you need to fill a vacancy to prevent losing money every month and there aren’t enough tenants interested in the property, you may have to accept a tenant you might not like to prevent negative cash flow. Even if you believe you’ve chosen well, dealing with strangers is not for everyone. Tenants will certainly not care for your property as much as you would if you were to live there. Even nice people can surprise you in a tenant/landlord relationship. To become a landlord with a successful business, you’ll need to be able to deal with people who might be different than you in terms of values and personality. Do you have cash and savings to buy the properties? The great thing about buying a house with cash rather than seeking a mortgage is that you can eliminate the expense of the mortgage payments. Every cent of rental income you receive, after maintenance expenses are paid, is profit. That can make the difference between a rental property business that succeeds and one that struggles. Leveraging your property purchase by using other people’s money — a mortgage — can turn out to be profitable when property values increase, but that’s not guaranteed. Loans open up the possibility of becoming a landlord to more people, easing the affordability of properties. Having the cash to buy the property outright is not necessary, but if you have the money and are willing to invest in your own business, it will be much easier to generate a positive cash flow. Can you charge high enough rent to cover your expenses? In some locations, monthly rental properties are very competitive. That can drive down prices, decreasing your profit. If you’re competing in an area where most investors own their properties outright without a mortgage while you do have mortgage expenses to contend with, you have less pricing flexibility than your competitors have. You need to charge high enough rent to cover your expenses and take home a profit. With mortgage payments to contend with and a tough competition, you may only be able to profit $200 to $400 per month on a property. That’s $4,800 a year, a far cry from the $50,000 we’re talking about for earning a living. You’d need to own over 10 properties profiting $400 per month in order to reach that target. With volume, you may be able to increase that per-property profit due to economy of scale, buying materials in broke, and receiving significant discounts from contractors. You might be able to reach the annual income target faster, but it will still take a long time to reach the number of units necessary. Use a mortgage calculator in determining how much profit you might generate. In other locations, though, you can charge much higher rent compared to the purchase price or mortgage payment. Property prices still tend to be high in New Jersey where I live, so potential for profit isn’t as great. Head to other areas of the country, and you can buy properties that command rental fees of $1,000 or more for just over six figures. If your monthly mortgage payment is $350 and the rent you can successfully charge is $1,000, your path to earning a living of $50,000 annually just got much clearer and shorter. With some time and volume, you could easily exceed this. How much work are you willing to do for an extra $400 a month? Work at the beginning may pay off when you add additional properties, but the path to millionaire status through rental properties is not as simple as television shows on HGTV might lead to to believe. You may profit in terms of your financial statements, but if you consider your time and your sweat equity worth something, the calculation gets a little trickier, particularly when you’re doing more work to get started. Even in markets were home prices have remained relatively high, it’s possible to earn a living with rental properties. The work isn’t for everyone, and that’s good; those who are willing to put the necessary labor into creating a successful business will be rewarded. Earning a living isn’t as easy as being a landlord for one property, however. Are you earning a l iving through rental properties? What lessons have you learned? If you’ve considered becoming a landlord but have decided against it, what held you back? If you’re looking to buy an investment property, you have to be open to finding them through sources you might not have thought of before. While many new real estate investors turn to traditional sources to find properties, such as the MLS or outbound marketing, there is one source that can provide a great return of investment without much marketing required: the good, old real estate auction. Unfortunately, many new investors are scared off by the real estate auction process, and are otherwise unsure of how to make an offer on a REO (real estate owned) property in an auction setting. How does one join a real estate auction? How do they work? And what can you do to boost your chances of finding a winner? Though there are no guarantees in the real estate investing business, and fewer still with a real estate auction, here’s a breakdown of the real estate auction process to make sure you’re as prepared as possible when the bidding starts. The Advantages Of Buying At Auction There are several potential advantages to buying a house at auction. While some houses will be priced higher than they are actually worth, and some will be too damaged to make them serious candidates for restoration and renovation, there will also be properties where the opening bid is a fraction of what the property is worth. There will also be undervalued properties where they are priced about right, and could be worth much more if properly renovated. From an investor’s point of view, foreclosure and lien auctions offer the opportunity to invest in one or more of these properties at a low price. After some work, they can then sell or rent those properties for income. Most foreclosure auctions give the additional benefit of offering potential buyers ample time to visit each property, do research, and make a list of which ones interest them. Another benefit is that there isn’t an extended time of negotiation or back and forth with a seller. This is a one-time auction; the winning bid is the winning bid. There are no other changing amounts, negotiations or fees. A bidder lines up payment, perhaps through private money lending or raised cash, and then owns the property. How A Property Gets To Auction There are several possible reasons why a home might go up for auction; the real estate auction process will vary a bit depending on why that particular house is going up for auction. However, the two most common reasons a house goes to auction are foreclosure and tax liens. A foreclosure auction takes place after the previous owner failed to make payments over a series of months and the bank or lender has “foreclosed” or taken possession of the property. The original lender sells the house in this situation, creating the starting bid — usually the amount owed, plus fees and expenses. Auction attendees can then make that bid, or higher, to get the auction ball rolling. A tax lien auction is similar, but the property is seized as a result of unpaid taxes or tax fraud. In this case, it is the lien being sold. Whoever owns that lien has the right to collect it from the property owner, or seize the property if they are not paid. (Note: Tax lien investing is its own nuanced strategy. For more information, check out this FortuneBuilders tax lien resource.) How The Auction Process Works More often than not, auctions will take place at a local courthouse. Sometimes, auction companies will choose another location that comfortably fits the expected number of participants for an auction. (The goal is always to get the highest recovery amount for the lender.) Tax lien auctions, on the other hand, are generally overseen and conducted by the local sheriff, since the seller is often the government. In each auction, there is a starting bid, usually determined by the total amount owed. If that initial bid is not met, in most cases the property is set aside and held by the lender or government to sell off in another manner in the future. As long as that first bid is met, normal auction rules apply. The investor who makes the highest bid and can meet the auction requirements, such as a cashier’s check or payment within “X” number of hours, wins and receives the paperwork to take ownership with that property. When an investor has paid in full they will be given a certificate of sale. And within at least 10 days, often sooner, they will be mailed a certificate of title. How To Join An Auction Each state has its own rules, but the basics will be the same. To participate and bid in one of these auctions, an investor must register ahead of time. Registration information is generally easy to find, wherever local auction information is found, and a bidding package is provided upon successful registration. Once you register, it’s all about research, research, research. What makes a great deal on a property not only depends on the value of the property up for auction versus the bid amount, but also how much work and renovation you must put in, and how much potential the auction property has in either resell value or rental property income. This means doing the following in the lead up to the auction:
Whether you're curious about the investment potential of real estate or simply sick of infomercials promising millions of dollars in returns from a new and obscure way of investing in real estate, it is worth learning how wealth is created through real estate. (For more information on buying a home, see: A Guide to Buying a House in the U.S.) We're not looking at strategies for how to profit from real estate. Instead, this article will focus on the basic ways that money is made through real estate. And, fortunately for us, these haven't changed in centuries, no matter what kind of gloss the gurus of the moment try to put on it. Tutorial: Exploring Real Estate Investments Appreciation The most common source of real estate profit is the appreciation — the increase in the value — of the property in question. This is achieved in different ways for different types of real estate. And, most importantly, it is only realized through selling or refinancing. If you are considering refinancing, then use our mortgage calculator to calculate current refinance rates. Raw Land The most obvious source of appreciation for undeveloped land is, of course, developing it. As cities expand, land outside the limits becomes more and more valuable because of the potential for it to be purchased by developers. Then developers build houses that raise that value even further. Appreciation in land can also come from discoveries of valuable minerals or materials, provided that the buyer holds the rights. An extreme example of this would be striking oil, but appreciation can also come from gravel deposits, trees and so on. Residential Property When looking at residential properties, location is often the biggest factor in appreciation. As the neighborhood around a home evolves, adding transit routes, schools, shopping centers, playgrounds and so on, the value climbs. Of course, this trend can also work in reverse, with home values falling as a neighborhood decays. Home improvements can also spur appreciation, and this is something a property owner can directly control. Putting in a new bathroom, upgrading to a heated garage and remodeling to an open concept kitchen are just some of the ways a property owner may try to increase the value of a home. Many of these techniques have been refined to high-return fixes by property flippers who specialize in adding value to a home in a short time. Commercial Property Commercial property gains value for the same reasons as the previous two types: location, development, and improvements. The best commercial properties are in demand, and that drives the price up on them. (For related reading, see 7 Steps To A Hot Commercial Real Estate Deal.) The Role of Inflation in Appreciation Of course, there is one major factor we skipped in our summary - the economic impact of inflation. A 10% inflation of the dollar means that your dollar can only buy about 90% of the same good the following year, and that includes property. If a piece of land was worth $100,000 in 1970, and it sat dormant, undeveloped and unloved, it would still be worth many times more today. Because of runaway inflation throughout the '70s and a steady pace since, it would likely take over $560,000 to purchase that land today - assuming $100,000 was fair market value at the time and all other factors remained constant. So, inflation alone can cause appreciation in real estate, but it is a bit of a Pyrrhic victory. Even though you may get five times the money due to inflation, many other goods cost five times as much to buy now. (Learn more in 5 Tales Of Out-Of-Control Inflation.) Income Generally referred to as rent, income - or regular payments - from real estate can come in many forms. Raw Land Income Depending on your rights to the land, companies may pay you royalties for any discoveries or regular payments for any structures they add. These include pump jacks, pipelines, gravel pits, access roads, cell towers and so on. Raw land can also be rented for production, usually agricultural production. Residential Property Income Although it is possible that you may earn income from the installation of a cell tower or other structure, the vast majority of residential property income comes in the form of basic rent. Your tenants pay a fixed amount per month — and this will go up with inflation and demand - and you take out your costs from it and claim the remaining portion as rental income. While it is true that you will get an insurance payout if your tenants burn down the place, the payout only covers the cost of replacing what is lost and is not income in a real sense. Commercial Property Income Commercial properties can produce income from the aforementioned sources - with basic rent again being the most common - but can also add one more in the form of option income. Many commercial tenants will pay fees for contractual options like the right of first refusal on the office next door. These are essentially options that tenants pay a premium to hold, whether they exercise them or not. Options income is sometimes used for raw land and even residential property, but they are far from common. What About REITs or MICs? Real estate investment trusts (REIT) and Mortgage Investment Corporations (MIC) are generally considered to be great ways of getting income from real estate. This is true, but only in the sense that real estate is the underlying security. With a REIT, the owner of multiple commercial properties sells shares to investors - usually to fund the purchase of more properties - and then passes on the rental income in the form of distribution. The REIT is the landlord for the tenants (who pay rent), but the owners of the REIT get the income once the expenses of running the buildings and the REIT are taken out. MICs are even a further step removed, as they invest in private mortgages rather than the underlying properties. MICs are different from MBSs in that they hold entire mortgages and pass on the interest from payments to investors, rather than securitizing the interest streams independent of the original mortgage. Still, they are not so much real estate investments as they are debt investments, and thus outside of our area of interest. (Learn more in How To Assess A REIT.) Smoke and Mirrors Similar to securities with real estate underlying the investment, most of the alternative "blow your mind with super fantastic return" methods are merely a layer on top of these two basic streams of income. For example, there are informal residential real estate options where you pay a fee to have the right to buy a house at a given time, say after a month, for an agreed upon price. Then, you find investors who will pay more than your option price for the property. In this case, the premium you get is essentially a finder's fee for matching a person looking for an investment with a person looking to sell - no different than a real estate agent. Although this is income, it doesn't come from buying (i.e. holding the deed to) a piece of real estate. Similarly, no money down or OPM deals are simply the financing aspect of the deal - it doesn't change how the buyer is planning to make money in the long run. The Bottom Line If someone is trying to sell you on a new way to make money in real estate other than buying low and selling high or collecting rent, they're probably trying to sell you on the process of real estate investing, rather than a new mechanism for making profits. Whether the process is worth it or not is up to you, but know that it doesn't change how the money will be made (or lost) in the end. |
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