Real estate is not purchased, held, or sold on emotion. Real estate investing is not a love affair, it’s all about a return on investment. And prudent real estate investors always consider the four basic elements of return to determine the potential benefits of purchasing, holding on to, or selling an income property investment.
Let’s look at these elements of return individually because being able to understand them, how they’re derived, and how to calculate the combined effect of all four properly is at the root of real estate investment success. You can determine what kind of profit can be achieved on a potential investment, and you can make sure your percentage return always stays high enough to ensure that you reach your investment goals on schedule.
Cash flow (i.e., “the bottom line”) The amount of money that comes in from rents and other income less what goes out for operating expenses and debt service (loan payment) determines a property’s cash flow. Cash in minus cash out equals cash flow. When more cash comes in than goes out, the result is “positive cash flow” you can pocket. When you have to spend more than you take in, the result is “negative cash flow” that requires you to dig into your pocket and feed the property. The goal, of course, is to be sure the property always produces enough cash to pay the bills, so always run the numbers.
One popular method is to create an annual property operating data. It creates a virtual “snapshot” of the property’s income and expenses for the first twelve month period, and when realistic income, expense, and loan data is feed in, the APOD provides you with the bottom line (whether positive or negative). It’s only one part of a good rental property analysis, but it does offer a quick and easy way for you to get an idea of the property’s financial performance.
Appreciation This is the growth in value of a property over time. Future selling price minus original Crowdfunding purchase price equals appreciation. To understand appreciation correctly, however, let’s begin with a fundamental truth about real estate income property. That real estate investors buy the income stream.
It stands to reason, therefore, that the more income you can sell, the more you can expect your property to be worth. Likewise, the faster you can increase the income stream, the faster your property will most likely appreciate. In other words, follow the revenue by deciding upon the likelihood of an increase and throw it into the decision-making. Here are some things to consider.
Market conditions – Is there anything about the location that could change and make the property more attractive, and thus shift the balance of supply and demand?
Economic inflation – Will rising costs of new construction generally drive rents upward?
Physical improvements – Does the property lend itself to improvements that might demand higher rents, attract and keep better tenants, or reduce vacancy losses?
Operating expenses and management – Are there wasteful expenditures you can readily minimize and thereby increase cash flow?
Loan Amortization This means a periodic reduction of the loan over time leading to increased equity. When mortgage payments include both principal and interest, each time your tenants pay you rent they provide you with cash to pay down your debt and, as such, help you to buy the property and in turn to make money.
Tax Shelter Tax shelter is a legal way to use real estate investment property to reduce annual or ultimate income taxes. Not unlike all tax matters, however, no one-size-fits-all, and the prudent real estate investor should check with a tax expert to be sure what the current tax laws are for the investor in any particular year.