How Does Investing in Real Estate Create Wealth?
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by: Kevin Kiene
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Many people may have heard that investing in real estate builds wealth, but are unsure as to how this takes place. Can it really be different from other investments? When investing in real estate, you may choose to buy and rent a property, or you may choose it "flip it" (buy and sell quickly). The safest way to invest is to buy wholesale properties that are priced right and that are located in safe and stable markets. The goal is to find an investment property with a solid positive cash flow that may appreciate in value over time. It is that combination of cash flow and appreciation that helps create wealth.
Positive cash flow is the amount of money that is left over after all of the expenses have been paid on the property at the end of the month. It is the profit that you have on your investment. Expenses that you deduct from the rent payments you’ve collected may include items such as operating costs, taxes, and the mortgage payment. The positive cash flow from a property will depend upon three different things: the amount of the rent being charged, the amount of the mortgage payment, and the cost of operating the building. To create wealth by investing in real estate, analyzing these three things is crucial.
Using borrowed money to finance your real estate investment is how many investors make a profit. They simply make money off borrowed money. One way to get a positive cash flow is to make a small down payment on the property, making certain you acquire a mortgage that has a low interest rate, and is possibly even fixed for the term of the mortgage. Currently, rates are still neat historic lows, so it is a great time to be looking at this. Basically, a lower mortgage payment means you will be getting a higher cash flow because your expenses will be smaller.
For example, if you purchase a four-unit apartment building for $125,000 and rent each apartment for $600 each month, you will receive $2,400 a month. Less your mortgage payment of $625 and operating expenses of $300, you should have a positive cash flow of $1,475. If, however, your mortgage went up to $925 per month, you would only have a positive cash flow of $1,175 each month. The key is to get the lowest payment possible and keep your operating expenses down as much as reasonably possible without sacrificing maintenance issues.
Another method of keeping a positive cash flow is to take out an interest-only loan. This type of loan usually is a short-term loan, usually about a five-to-ten year length of time, in which you are paying the interest only. After the period of the loan ends, you will need to either sell the property or refinance. This, however, does give you a low payment during the term of the loan and will help you to get a higher positive cash flow from your investment property, even for a short period of time.
With a positive cash flow coming in from your investment property, you can acquire more investment properties. One way to do this is to refinance your current investment property, using the money you get to help you acquire another investment property and so on. In this sense, you are creating positive cash flow from several properties and you haven’t had to pay the capital gains tax on the original property as you did not sell it, but instead, refinanced it to help you purchase more properties.
The most important thing to remember is that if you want to create wealth by investing in real estate, you must maintain a positive cash flow on your properties. By making certain your mortgage payment is as low as it can be, keeping the operating expenses at a minimum, and pricing the rent amounts correctly, you will find that you will not only create a positive cash flow, you will be able to create the wealth you want for yourself.
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