In a traditional rental property situation, an investor buys a property and rents it out to tenants. The property might be a single family home, a student accommodation, a condominium apartment, or a multi-family residential property. In exchange for the right to occupy the property, the tenant pays the investor or the landlord a pre-determined amount of rent, typically on a monthly basis, for the duration of the rental period.
If done properly, the beauty of this arrangement is that the investor builds wealth from not just one, but from three distinct pillars.
Cash flow is usually calculated by adding the rental income from all sources followed by subtracting the expenses and mortgage payments. If there is money left over at the end of the month after all expenses and mortgage payments have been made, the investor is in a positive cash flow situation. When the property isn’t producing enough income to cover all of the expenses including mortgage payments, the investor is in a negative cash flow position. Needless to say, investors aim to buy positive cash flowing properties or properties where cash flow can be increased in the near term. The benefits of owning a property with positive cash flow is that the investor can spend the money any way he or she chooses. That said, I know many investors who re-invest the extra money back into their properties by topping up their reserve funds or by performing renovations that increase the value of the property. It’s also important to know that when a market or home prices experience a downturn, the investment is buffered by the cash flow that is still coming in.
If you own a personal residence, you probably know that your mortgage payments include a principal portion and an interest portion. The principal portion is the amount of money that was borrowed and is still owed to the lender. One benefit of being a real estate investor is that the rental income collected from the tenant is used to pay down the mortgage, including the principal, month after month and year after year. That’s right, you own the property and someone else pays the mortgage! This is why it’s important to build relationships with tenants and treat them like clients!
There are two types of appreciation in real estate investing world. The first is called market appreciation and it occurs when a property increases in value over a period of time based on market forces. Of course, there are times when property values decrease or depreciates and investors need to be aware that it happens. That said, 2014 saw UK Real Estate investment volumes hit record highs of £65bn.
The second type is called forced appreciation and it happens when improvements have been made to the property. For example, updating a 1970’s era kitchen to today’s kitchen styles will help increase the overall value of the property.
These pillars are the three ways investors can win and build wealth with real estate. There are many investment opportunities out there, but these three pillars are why people invest in real estate.
Originally written by Tony Miller, a real estate agent in Ottawa, and modified for Aspen Woolf on 10/02/2015.