Real Estate investors can generate millions of dollars through their real estate investments, but how exactly does it all work? Learn more about how real estate can transform into wealth.
For many, real estate is simply buying a home to live in. Real estate investors use properties to generate wealth in a variety of ways. Real estate can generate wealth for investors in the following three ways: appreciation, cash flow, and equity. Though there are many investment styles to choose from, real estate investors use a combination of these three ways to generate wealth from their real estate investments.
Over time real estate increases in value. This process is called appreciation. Though there have been some notable exceptions to this rule (2007/2008), real estate increases in value year over year. For example, home values in the US have gone up 6.7% according to Zillow.com. They expect them to rise another 3.2% in the next year. So, if you bought a home for $200,000 a year ago, it could now be worth $213,400. Appreciation generated over $10,000 of wealth, in just a year.
Cash flow is the term investors use to describe the amount of profit a rental property generates after revenue from rent and any expenses are accounted for. It’s most often expressed by this simple equation:
Rent – (Expenses + Mortgage Payment) = Monthly Cash Flow
Before purchasing a property, investors ensure that the final “Monthly Cash Flow” number is positive. For many buy and hold investments, this number can be modest; however, when you consider that investors generally have a portfolio of units, it adds up quickly.
Many investors take advantage of conventional financing to secure rental properties. For example, the $200,000 home they purchase, they put $40,000 down, and then take out a 30-year mortgage on the remaining $160,000. The rent the tenant pays goes towards that monthly mortgage payment. So the investor leveraged $40,000 to eventually build $200,000 of equity. Creating equity in a property is one of the ways investors generate wealth.
Generating Wealth Through Real Estate Investing
There is no simple formula for generating wealth through real estate investing; however, all investors use some combination of appreciation, cash flow and equity to create their personal wealth. Investment style, personal goals and market conditions affect what portion of the investor’s wealth comes from each element, but all work together to achieve the investor’s financial goals.