The 4 Investment Returns of Real Estate

All measures of income-property investments deal with either cash flow, appreciation, tax benefits, or loan amortization/pay down. These are the ways you can make/save money with income property.

CASH FLOW is the revenue you receive from an investment property. You will need to subtract the total of all expenses from the total income to get the Net Operating Income (NOI). You will then subtract mortgage if applicable to get the cash flow. An example is as followed:

Cash In

Total Rental Income = $1400

Subtract the % of vacancy and credit loss (8.50% = $119)

Add other monthly income = $0

Gross Monthly Operating Income = $1,281

Total Annual Operating Income = ($1281 x 12) = $15,372

Cash Out

Property Management Fees (8%) = $102.50

Property Taxes = $60

Capital Expenditure Reserves (CapEx) = $192 (Assuming 15% of Gross Monthly Income)

Hazard Insurance = $0

Water/Sewer = $0

Gas = $0

Garbage = $10

Repairs and Maintenance = $128 (Assuming 10% of Gross Monthly Income)

Accounting = $30

Legal = $40

Landscaping = $20

Snow Removal = $20

HOA (if applicable) = $0

Other/ Miscellaneous = $64 (Assuming 5% of Gross Monthly Income)

Monthly Operating Expenses = $666.50

Total Annual Operating Expenses = ($666.50 x 12) = $7,998

NOI

Operating Income – Operating Expenses ($15,372 - $7,998) = $7,374

Cash Flow

Now don’t forget to subtract out the mortgage if applicable. For this example, I will assume the property was bought all cash with no financing, therefore the NOI = Cash Flow = $7,374

APPRECIATION is the concept of a property’s value increasing over time, therefore building equity. You can force this appreciation by rehabbing (value add). The formula for this is simple:

Future resell price – original purchase price = appreciation

For Fix and Flip investors the formula is a little different. Single family or small multi-family investors may use the following formula or something similar:

After Repair Value (ARV) x .70 – rehab cost

$200,000 x .70 - $40,000

$100,000 is the highest purchase price if using the ARV x .70 method

You are all in at $140,000 because you paid $100,000 for the property and spend $40,000 on the rehabilitation. The ARV is $200,000

There is potential to make a $60,000 profit. This figure does not include closing cost to keep the math simple.

Assuming the market value is $130,000 before rehab (You paid $100,000), your property appreciated $70,000 if the ARV is $200,000.

TAX BENEFITS would include deductible expenses and depreciation of real property over 27.5 years; does not include the land that the property sits on. Due to these benefits, Individuals in real estate pay the lowest percentage of taxes on for profit income (passive investors NOT active investors). Investors get taxed on either their NOI/ cash flow or capital gains. You can lower your tax basis by deducting depreciation and expenses. Example:

NOI from example above is $7,374

You can subtract depreciation (cost recovery) and/or deductible expenses such as

• Mortgage Interest (if applicable)
• Property Taxes
• Insurance
• Utilities
• Maintenance and Repairs (Not rehab)
• Improvements (Can be depreciated)
• Advertising and Marketing
• Auto and Travel
• Supplies/ Tools
• Property Management
• Legal/ Professional and Accounting Fees

The list goes on and on. Talk with an experienced CPA or lawyer about additional benefits or how to deduct the expenses listed above.

LOAN AMORTIZATION/PAY DOWN is the ability to build equity each month by paying down the mortgage. Payments go more toward interest at first (little equity being built), but gradually increase the principle payments years down the line to build equity. Toward the end of the amortization period, most of your monthly payments are going toward to principal. Monthly payments will be the same throughout the mortgage (Payments going mostly toward interest in the beginning, and more toward the principle in the end). With all of this said, why spend money to build your wealth when others can do it for you through passive methods of investing (rental properties)?

Stay tuned for future updates! I will write two post each month.