The Four Wealth Producers of Real Estate: An Accountancy Lesson

Fellow investors, gather around for an accountancy lesson about the four producers of wealth and real estate!

First, we have CASH FLOW. It's simple, folks.

Revenues > expenses = positive cash flow

When we have more money coming in than going out, we have a positive cash flow! And that's a good thing. This way, we have a steady stream of income, usually in the form of rent payments, to cover all the expenses and have some extra moolah left over. You can have 10 properties that each cash for $500 for a total of $5,000 in cash flow generated per month or you could have four properties that each cash flow $2,000 for the same total per month. How you produce cash flow is totally up to you. The best part is, this cash flow is mostly passive, meaning we don't have to trade our time for money. That's why real estate investing is so scalable!

Next, we have APPRECIATION. It's when the value of your property increases over time, like a fine wine. And it's all natural! Appreciation is a wealth producer because it rolls the equity on your property. If you were to purchase a home at $250,000 and then a year later it’s now worth $265,000 use now again $15,000 due to natural appreciation. But we can also add some force to it by making some renovations and improvements. If we buy the property under its market value (ARV) which stands or after repair market value, or at a discount. Using force appreciation is one of the quickest ways to increase the value of the property. Make it look fancy, we can quickly increase its value. And when the value goes up, so does our equity! That's why appreciation is a wealth producer. It's like a double win!

So let’s explain how appreciation can increase your wealth. If you think about the accounting of it when your property appreciates, your equity also increases. An accounting you have was called the accounting equation which is your assets minus liabilities, equal owners equity.

Assets – Liabilities = Owner’s Equity 

Assets (homes) comprise both a liability (your mortgage debt) and equity (your own value in the home). The more your property appreciates, the more equity you have in the home. Below is essentially the accounting equation as it relates to real estate: Property value – mortgage debt = your equity

Thirdly, we have EQUITY BUILDUP THROUGH LOAN PAY DOWN. You see, when we pay off our mortgage, our equity in the property increases. Every time we make a mortgage payment, we're paying down the principal and reducing the mortgage balance. For example, if you have a monthly mortgage bill of $1000 on a $160,000 a year loan the first $980 goes toward interest, and $20 those toward the principal. At the end of the month, your loan balance is now $159,980 ($160,000 -$20). The equity in your property has increased by $20 in one month. Your accounting equation looks like this: $200,000 property value -$159,980 mortgage = $40,020 equity.

The deal gets even sweeter. If you have a renter in your property that’s making the rent payments monthly because you can use their payments towards the principal and interest without having to use your own money. They're helping us pay off our mortgage with their rent payments. So, they're building our equity with their money! How cool is that?!

And last but not least, we have TAX BENEFITS. Now, I'm not a tax advisor, but I can tell you that the government likes us real estate investors. If we use it right, we can save a lot of money! There are things like pass-through deductions, write-offs, depreciation, and 1031 exchanges that can decrease our taxable income and reduce the amount of taxes we have to pay. But remember, always consult a tax professional before making any moves.

And there you have it, folks! The four producers of wealth and real estate!

Let's start investing!