When investing your money in the stock market, the only way the typical investor can make money is for the stock to appreciate (raise in value), and you sell your stocks at a good time. With real estate the typical investor can make money in many ways, some of which are listed below.
Rental income: The monthly income received for renting out a property. If the property was purchased with a loan, rental income can make the payment monthly, ultimately paying for the property. You can putting any extra money in your pocket or apply the money towards the loan therefore adding to your equity.
Buying low. You turn an instant profit if you manage to buy a property for under market value. Think foreclosures, distress sales & ‘fixer-uppers’.
Selling high. You can make extra money if you stage the property to attract buyers to pay top market price. With stocks, you always buy and sell at market value. With real estate, you can try to beat the market by providing a product that exceeds market expectation and appeals to a large market share.
Increasing equity. If you take out a mortgage to finance a rental, you are increasing your equity with every mortgage payment. For example, if you put down 25% on a rental and pay your monthly mortgage payments, you can increase equity with every payment. Your interest amount decreases, and your principal payment increases with time therefore adding to your equity.
Leverage increases returns. If you put 20% down on a property, you will still receive rental income based on 100% of the property value, making it a great return for your 20% investment. Say your property is worth $100,000 and you charge $750 in rent with $500 in mortgage, taxes and fees. You have a $250 profit on $20,000 down. That is $3,000 a year, or a cool 15% return on your deposit. Good luck trying to get an almost guaranteed 15% on stocks.
Leverage makes you profit on the full selling price. If that same $100,000 property you bought with $20,000 down sells for $120,000 a few years later, you get your $20,000 plus principal payments back, and a $20,000 profit. It is only a 20% profit over the full value of the property, but thanks to your leverage, you are making a profit of 100%, minus principal payments to the $80,000 mortgage. The bigger the leverage, the greater the return. Use caution in over leveraging your real estate investments should prices decrease in an economic downturn.
Renting smaller units. You can rent three rooms by the room, to three tenants. You can charge more than if one family was renting the whole place in some neighborhoods i.e. college areas.
Renting to businesses. Businesses are a different type of tenancy and rents are generally higher. They are also safer if you choose a well-known business or franchise to rent to.
Tax benefits on interest. Depending on your IRS regulations in effect, you can often deduct the mortgage interest from the rental income and create a tax-free profit.
Tax benefits on improvements. You can also deduct the cost of the improvements from the rental income, while adding value to the property. Be sure to investigate the opportunity zone to see if you are located within one.
Profit from a lump sum on a refinance. So you bought your $100,000 place, and put $10,000 worth of improvements, that the tenants paid back with rents. The property is now worth $125,000 because your contractor did a great job, you can refinance to get the $25,000 cash and put 25% down on your next $100,000 rental!
Profit from extra cash flow on a refinance. If you can refinance the property to lower your mortgage payments while the rent stays the same, you are generating more cash flow every month. You can build a cushion for maintenance, save up for a deposit on a new rental, or have more passive income to live off.
Take advantage of tax incentives: Programs with tax incentives like 1031 exchange to defer taxes, the opportunity zone program to eliminate taxes and self-directed IRA’s can result in a huge savings to the taxpayer.
Extra retirement income: Building a real estate portfolio can provide supplemental rental income in retirement once rental properties are paid for, should the investor choose to keep rental properties after being paid off.