How Real Estate Make Money?
Surely you have heard that you can earn a lot of money investing in real estate but you do not know exactly how to do it. In this article, I explain the main ways to make money investing in real estate so that you too can put them into practice and make money in the real estate market.
Real Estate Profits From Increasing Property Value
The most common way real estate offers a profit: It appreciates—that is, it increases in value. This is achieved in different ways for different types of property, but it is only realized in one way: through selling. However, you can increase your return on investment on a property in several ways. One way—if you borrowed money to buy the property—is to refinance the loan at lower interest. This will lower your cost basis for the property, thus increasing the amount you clear from it.
Real Estate Profits From Income
The second big way real estate generates wealth is by providing regular payments of income. Generally referred to as rent, income from real estate can come in many forms.
Raw land income
Depending on your rights to the land, companies may pay you royalties for any discoveries or regular payments for any structures they add. These include, for example, pump jacks, pipelines, gravel pits, access roads, and cell towers. Raw land can also be rented for production, usually agricultural production, and land tracts with trees may be valuable for the timber that can be periodically harvested.
Residential property income
The vast majority of residential property income comes in the form of basic rent. Your tenants pay a fixed amount per month—which will go up with inflation and demand—and you take out your costs from it, claiming the remaining portion as rental income. A desirable location is critically important to ensure that you can secure tenants easily.
Commercial property income
Commercial properties can produce income from the aforementioned sources, with basic rent again being the most common, but can also add one more in the form of option income. Many commercial tenants will pay fees for contractual options like the right of first refusal on the office next door. Tenants pay a premium to hold these options whether they exercise them or not. Options income sometimes exists for raw land and even residential property, but they are not common.
Residential Real Estate: Paths to Profits
Here is a closer look at some of the many ways that you can earn income from residential properties.
Buy and hold
This is one of the more traditional ways of earning income from real estate. There are a number of ways to accomplish this: You can buy a single-family home and rent it out; buy a multi-family home and live in one of the units while renting the others—ideally to cover the mortgage and your own housing expenses; or purchase a multi-family home and rent all of the units—either managing the property yourself or hiring a management company to handle renting units, collecting rent, addressing needed repairs, and so on.
Property flippers specialize in adding high-return fixes to houses in a short time and then selling them. Flipping can be lucrative if you know how to find properties to fix up, you have the necessary skills to do the renovations yourself or oversee a crew carry them out, and you have a sense of a property's underlying costs and potential value.
Airbnb and vacation rentals
Although the COVID-19 pandemic has put the breaks on it for now, the demand for home-away-from-home rentals had taken off in recent years as many travelers preferred this option to stay in a hotel. Homeowners could earn income by renting out a house or even just a room on a short-term basis, especially if the property is in an area that's a well-known tourist destination.
It's unclear when that market will return. But should it reappear, keep in mind that short-term rentals are regulated and sometimes even banned in certain cities. Check your city's bylaws before listing a property on a website such as Airbnb, VRBO, or HomeAway. And also figure out what additional deep cleaning and sanitizing between guests will add to the costs.
Alternative Real Estate Income Sources
Real estate investment trusts (REITs)s, mortgage-backed security(MBSs), mortgage investment corporations (MICs), and real estate investment groups (REIGs) are investment alternatives within the real estate sector. They are generally considered vehicles for deriving real estate income but they have varying processes for doing so and varying processes for entry.
With a REIT, the owner of multiple commercial properties sells shares (often publicly-traded) to investors (usually to fund the purchase of more properties) and then passes on the rental income in the form of a distribution. The REIT is the landlord for the tenants (who pay rent) but the owners of the REIT record income once the expenses of operating the buildings and the REIT are taken out. There's a special method to assessing a REIT.
MBSs, MICs, and REIGs
These are even a further step removed, as they invest in private mortgages rather than the underlying properties. MICs are different from MBSs in that they hold entire mortgages and pass on the interest from payments to investors, rather than securitizing portions of principal and/or interest.
Still, both are not so much real estate investments as they are debt investments. REIGs are usually private investments with their own unique structuring, offering investors equity investments or partnership servicing.
Now you know what are the main ways to make money investing in real estate.
Here you can find the best options to invest in real estate in the finest areas of the country.
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