Ashley Hamilton waited tables from dawn to dusk every weekend. As a single mom at 23, she was determined to both (1) provide for her children, and (2) be present in her home. After packing in 35 hours of waitressing each weekend, Ashley was only taking home $22,000 each year.
Today, she’s a millionaire. She owns 18 properties. But most importantly, she has time to invest in her children.
You’ve heard of stories like this—the potential to get rich passively through real estate is real. In fact, 90% of today’s millionaires, like billionaire Jane Goldman, built their wealth through real estate.
That’s because, unlike other investments (like the stock market, bonds, and savings accounts), real estate increases your wealth in 5 different ways. Today, you’ll learn what these 5 profit centers are and how to leverage them.
- Cash Flow
Cash flow is the difference between your expenses and your income. Your expenses may include your mortgage payment, mortgage insurance, homeowner’s insurance, utilities, property taxes, home repairs, HOA fees, property management, general property upkeep and management, and any costs due to vacancies. Your income includes your tenant’s rent plus any application fees, late fees, etc.
Generally, “good” cash flow for a rental property hovers around $100 to $200 a month per unit (though even this may be difficult with current mortgage conditions). You won’t know your exact cash flow until you know the mortgage payment for each month. However, you can estimate cash flow on a property before you buy it. In fact, banks or private money lenders often want to see these calculations before they’re willing to lend you money.
To find the potential cash flow of a property:
- Calculate the gross (or total) income you’d collect on the property over one year
- Determine the gross (or total) operation expenses you’d have to cover on the property over one year
- Calculate your net operating income (NOI) by subtracting the operating expenses from the gross income
- Divide this number by 12 to find your potential monthly cash flow
- Tax Savings
Homeowners can deduct mortgage interest rates from their taxes. While this might not sound like a big deal initially, a closer look at the books will show you how impactful this profit center is.
On your investment property, you can write off 100% of the interest you’re paying on your loans, for example. When you pay for a mortgage during the first 15 years of owning your property, very little goes to the principal, and most goes to the interest on the loan.
When you write off this expense, it decreases your taxable income, in turn decreasing how much you owe in taxes. Real estate write-offs can reduce your taxable income enough to save you tens of thousands of dollars each year that you’d otherwise be paying to Uncle Sam.
Appreciation is the rise in a property’s value over time. A property’s value is determined by how much it would sell for on the open market. This value changes over time. The conditions in your local real estate market, the condition of your property, as well as any improvements or additions you’ve made all play into your property’s value.
While temporary drops in value (called depreciation) are possible in real estate, home prices have increased significantly and steadily for the past 80 years. Since 2021, the average annual home price increase has been 7.7%, according to the FHFA.
Home price appreciation can also vary significantly from state to state. In 2022, home values in Texas (where we’re from), for example, increased by 5.07%. But in Arizona, home values increased by only 0.67%. And in Utah, homes actually dropped (or depreciated in value) by 4.35%.
While appreciation is one of the highest profit centers of a rental property, it’s also speculative and can fluctuate year to year. For this reason, rental properties often bring the most wealth when they’re used as long-term investments.
- Hedge Against Inflation
Inflation decreases the purchasing power of a dollar. What a dollar could buy in 1950 now takes $10 to purchase. It’s frightening, especially if you’re locked into an income that doesn’t keep pace with inflation. While inflation’s effect on our groceries and day-to-day purchases adds to our financial strain, our investments, like retirement accounts, take the biggest hit when the value of the dollar decreases.
But real estate has earned a reputation as an “inflation-hedging investment.” Unlike stocks, bonds, and mutual funds, real estate can actually bring in more money as inflation rises.
For real estate investors, inflation can be good news because it gives you an opportunity to increase rent. With a fixed-rate mortgage, your monthly payments won’t increase, so you may be able to increase your monthly cash flow by increasing rent. Inflation, therefore, can help with both the overall equity in your property and the tangible cash flow hitting your pocket.
Equity is your property’s market value minus how much you owe on your mortgage. When you rent out one of your homes, your tenant’s rent is most likely covering or exceeding the property’s monthly mortgage. Month after month, someone else is paying back your loan and increasing that gap between how much your house is worth and how much you still owe to the bank.
To figure out how much home equity you have, first, find the appraised market value of your home. Subtract the remaining balance on your mortgage. This number shows how much you would pocket if you sold the house.
5 Simple Steps to Financial Freedom
The 5 profit centers of real estate allow you to build wealth much more quickly than traditional investments. Want to tap into this financial freedom? Whether you’re looking to purchase your first or fifth rental, we’ll help your investment grow. Here are the 5 tried and true steps that will make your real estate investments profitable.