Thursday, January 18, 2018

Five Ways of Making Money in Real Estate

Cheers to All of 2017 Successes!
Yesterday, I attended the first meet-up of 2018. I really enjoyed it.

My favourite part was when everyone in the room took a turn to share some of their 2017 wins.

It is truly inspiring to hear so many success stories. Collectively, the group probably bought and sold a couple of hundred of properties last year.

There were some over-achievers among us. For example, one gentleman completed 11 flips, 4 wholesales and 2 buy-and-holds. That is a lot!!! Bravo

I'd like to share what I learned about five ways of making money in real estate. When I was starting with my 50 doors plan, I only understood one of these money making techniques - the cash flow part. But it is important to be aware of and take advantage of all other components.


1) Cash Flow


Cash flow is the money that you make every month when you buy and hold real estate:

Cash flow = Income - Expenses - Financing Costs

Usually, cash flow is fairly skinny. My goal with each of the new properties is to have a cash flow of $200 per month. However, in some cases, I start out with cash flow being as low as $50 / month. Over time cash flow will grow, if you manage your property well and find ways to increase income and optimize expenses.  

Let's suppose you make about $200 / month in cash flow. Over five years, this adds up to


$200 x 12 x 5 = 12K


2) Appreciation


Appreciation is the bonus that market gives you. It is important to do through market analysis and understand what, where, when and why makes the most sense to invest in when you purchase a property. This helps ensure that you catch a rising wave, not a avalanche down.

Appreciation = Price of your Property Now - Price that you Paid for it

If you purchase a property at a fair market price and a fairly stable location and your plan is to hold it long term, then it is pretty safe to assume that appreciation will be on average 2%. Let's suppose you purchase a property for 200K and hold it for 5 years. Appreciation will be 200 x 2% x 5 = 20K.

Let's suppose that you decide to keep the property. In that case, you can refinance and pull out 65-80% of appreciation. This means that at refinance you will get

20K * 65% = 13K



3) Principal Pay Down



If you have a traditional mortgage on your property (not interest only financing), then every month a portion of your mortgage payment goes towards principal pay down and the rest is the interest that the lender collects.

Principal Pay Down = Current Mortgage Balance - Initial Mortgage Balance

Let's say that you purchase a property for $200K, with 20% down payment and a 3.5% interest mortgage for the remaining 160K for a 5-year term and with 30-year amortization. At the end of the term, your mortgage balance will be about 143.5K.

This means that at refinancing, you can get

(160 - 143.5) x 65% = 10.7K


4) Forced Appreciation


Forced appreciation includes cash flow and value increase due to the improvements that you make to the property. Suppose, you invest an additional 5K after you purchased the property and got a better tenant at a higher rent. The tenant pays an additional $50 / month.

Also, let's assume market cap rate is 5%.

Forced Appreciation = Increased Cash Flow + Increase in Value - Investment

In this case, your annualized cash flow increases by another $50 x 12 = $600, or 3K over 5 years. The value of the property increases as well by $600 / 5% = 12K. Forced appreciation is


3K + 12K - 5K = 10K



5) Annuity


There are various ways how you can turn your property into an annuity and be getting a lump sum every month for the rest of your life. It would be wise to consult with an accountant or financial adviser to find the option with minimal tax implications.


Annuity = Get a Payment Every Month For the Rest of Your Life


TOTAL RETURN IN 5 YEARS


An investment of 45K gives you 43.7K in 5 years. This is over 100% overall and 20% per year.
  • Cash flow 12K + 
  • Appreciation 13K + 
  • Principal Pay Down 10.7K + 
  • Forced Appreciation 10K
  • TOTAL: 43.7K 
  • ROI: 20% per year
Not bad! I believe more champagne is in order! Wouldn't you agree?