There are four primary ways that you can make money in real estate. You can buy fix and sell a property, you can buy and hold a property, you can take advantage of tax benefits and you can take advantage of principle reduction and appreciation.
When you put a property under contract and sell your contract or you buy fix and sell a property these methods involve forced appreciation. Forced appreciation allows you to make a lump sum profit. You can also buy below market and sell at market for a quick lump sum profit. These are the primary ways to get cash from investing in real estate if quick cash is your primary goal.
If you are looking for income you should purchase a property and hold it while it appreciates. The first thing that you want to verify before you buy an investment property is if it will cash flow. Right now in the U.S., based on the loans that are available, it is easy to figure out if your properties will cash flow. For Example, take a $200,000 property and multiply it by .007 and you get a $1400 a month payment. If you have $1400 per month in rent, then you will break even. If you receive more than $1400 per month then you have cash flow. When you hold a property, you want to make sure that it will pay for itself.
Another way to profit from real estate is through the tax advantages. The following is an example only and any actual tax advice should be sought from your tax advisor. Because this is only a blog, we will not go into great detail on how to take advantage of depreciation.
Here is an example of how depreciation works. Start by taking the purchase price of the building and multiplying by .75%. That is an example of how much the building is worth compared to the land. (This comes from your tax bill that shows the relation between the land and the building.) If we use a $600,000 property the ratio would equal $450,000. If the property is a 1-4 unit you divide by 27.5 years; if the property is 5 units and above you divide by 39 years. We will assume that this is a residential property. Take the $450,000 and divide it by 27.5 years this equals $16,363. Now take this number and multiply by your tax bracket. In our example we are going to use 20%, therefore you would have a tax savings of $3272 for that year. To be clearer on this idea, ask your accountant or CPA. This is just an example and everyone’s situation is different.
Finally, the fourth way a property makes money is from principal reduction.
When you have a loan on the property, a portion of each monthly payment reduces the balance remaining on the loan. Each month you owe less on the property while the property should continue to appreciate in value.
You are making money between what the property is worth at a later date as opposed to what you purchased it for, that’s the appreciation piece. You are also making money between the loan balance when you purchased it and the loan balance when you sell the property. The tenant is paying down the principal mortgage balance for you, which gives you additional profit over time.
Here is an example of principal reduction. A $200,000 property, with an 80% loan to value, results in a $160,000 loan. If we assume that the interest rate is 4.2 % for 30 years then the 1st year of the loan the principal is reduced by $2,721. You can take the combination of the principle reduction and the amount the property increased in value from appreciation and add that into your profit.
Richard Maryanski and Erik Maryanski
Richdad Elite Trainers and Mentors
Additional Comments by Keith Gensor
Director of Education & Student Development
One of the best things about Rick & Erik Maryanski’s Creative Financing class is that you get to rely on their decades of experience & wisdom as successful Real Estate Investors.
With that experience & wisdom comes reason & logic – a systematic way of investing in real estate, that removes the emotion and the preconceived notions of what makes a deal a deal. Instead of having a hypothesis and then skipping the “experiment” so that your conclusion always matches, the experiment (otherwise known as a formula) is presented and always shows what makes a deal a good deal.
Creative financing is all about moving money around and managing your money to ensure that you are getting the best return. The answer to every potential deal is “It depends.”
Is this a good deal, it doesn’t cash flow? It depends.
Is this a good deal, there isn’t any appreciation? It depends.
Is this a good deal, there are no tax benefits? It depends.
Is this a good deal, there isn’t any principle reduction? It depends.
Unless you run the numbers and know exactly what your potential rate of return is, you’re running on feelings & emotions. Feelings & emotions will cost you more money than it will make you.
As Rick & Erik say, “What I like does not matter to making money.” Making money should be the end result of a logical & methodical system. Granted there is a lot of guesswork & speculation, and we all know that hindsight is 20/20. But if you conduct your due diligence, you should be able to minimize your risk & exposure and know (all things being considered) if you have a potential good deal.
What is this formula that I am referring to? Well Rick mentioned it to you in the preceding blog. If you want an in-depth explanation of how this works and how to apply it to your Real Estate Investing, then I highly suggest you enroll in the Creative Financing Class, as this is one of the most eye-opening classes we offer at Rich Dad Education. One that will enable you to look at every – residential or commercial, big or small, foreclosure or retail, & so forth – to determine if this is the highest & best use of your time & money.
Remember, the more ways you know how to make money equals the more potential to earn money. Learn this creative technique and you will forever see all of the investing opportunities in an entirely new way.