4 Factors to Consider when Investing in Real Estate

Real estate investments can be a good way to build wealth through capital appreciation and generate passive income through positive cash flow. However, it is important to carefully evaluate a property's potential return on investment before making a purchase. To do this, consider the expected rental income, operating expenses, and potential appreciation of the property. If a property does not generate positive cash flow or is not expected to increase in value, it may not be a good investment.

1. Rent Growth: Rental growth can significantly increase the cash flow from a rental property by raising the rent over time while keeping the mortgage at a fixed rate. For example, if a property generates a monthly cash flow of $200 from rent of $1,000, a 20% increase in rent to $1,200 would double the property's cash flow to $400. This can be a powerful way to increase the profitability of a rental property over time.

2. Appreciation, or the increase in a property's value over time, can also be a factor in the profitability of a rental property. Some markets may experience rapid appreciation, resulting in significant increases in the value of a property over a short period of time. However, relying solely on appreciation and not considering cash flow can turn a real estate investment strategy into speculation. It is important to consider both appreciation and cash flow when evaluating the potential return on investment of a rental property. Markets with a history of solid appreciation may also offer opportunities for forced appreciation through renovations. Leverage, or the use of borrowed funds to increase the potential return on an investment, can also be a factor in maximizing the benefits of a property's appreciation. While you may only have a percentage of the equity in a property through a mortgage, you can take advantage of the full increase in the property's value through leverage to purchase additional properties.

3. Cash flow, or the net income generated by a rental property after deducting operating expenses, is an important factor to consider when evaluating the potential return on investment of a rental property. Adequate cash flow can provide a margin of safety for investors, allowing for savings towards capital expenses, future renovations, and unexpected emergencies. When analyzing potential investment properties, it is essential to ensure that the projected cash flow is sufficient to cover the mortgage, maintenance, and tax payments. Even if a property is expected to appreciate significantly in value, it may not be a good investment if it does not generate sufficient cash flow to support the expenses associated with owning and maintaining it.

4. Long-term leverage, or the use of borrowed funds to increase the potential return on an investment over time, is an important consideration when investing in rental properties. As the mortgage is paid down over time, the property builds wealth for the owner through principal paydown. This can be thought of as a forced savings plan funded by the rent paid by tenants. Ensuring that the property generates sufficient cash flow is key to maximizing the benefits of long-term leverage. When cash flow and principal paydown are combined, they can create a powerful compound effect that can significantly increase the return on investment of a rental property over time.

Investing in rental properties can be a good way to generate passive income and build wealth through capital appreciation and long-term leverage. However, it is important to carefully evaluate the potential return on investment of a property before making a purchase. Factors to consider include the expected rental income, operating expenses, and potential appreciation of the property. Cash flow is also an important consideration, as it provides a margin of safety and allows for savings towards capital expenses and other expenses associated with owning and maintaining a rental property.