When it comes to making money in real estate investing, there are only a handful of ways to do it. Though the concepts are simple to understand, don’t be fooled into thinking they can be easily implemented and executed. An understanding of the basics of real estate can help investors work to maximise their earnings. Real estate gives investors another portfolio asset class, increases diversification, and if approached correctly can limit risks.
- An increase in property value
- Rental income collected by leasing out the property to tenants
- Profits generated from business activity that depends upon the real estate
Real Estate Increase In Property Value
First, it’s important you understand that property values do not always increase. This can become painfully evident during periods like the late 1980s and early 1990s, and the 2007-2009 when the real estate market collapsed. In fact, in many cases, property values rarely beat inflation—the increase in average prices in an economy.
Inflation and Real Estate Investing
When inflation happens a naira has less buying power. It happens because the government has to create—print—money when it spends more than it takes in through taxes. All else equal, over time, this results in each existing dollar losing value and becoming worth less than it was in the past. One of the ways that the savviest real estate investors can make money in real estate is to take advantage of a situation that seems to crop up every few decades. They do this when the rate of inflation is projected to exceed the current rate of long-term debt. During these times, you might find people willing to gamble by acquiring properties, borrowing money to finance the purchase, and then waiting for inflation to increase.
Cyclically Adjusted Cap Rate Purchases
The trick is to buy when cyclically adjusted cap rates—the rate of return on a real estate investment—are attractive. You buy when you think there is a specific reason that a particular piece of real estate will someday be worth more than the present cap rate alone indicates it should be.
Rental as a Real Estate Investment
Making money from collecting rents is so simple that every six-year-old who has ever played a game of Monopoly understands on a visceral level how the basics work. If you own a house, apartment building, office building, hotel, or any other real estate investment, you can charge people rent in exchange for allowing them to use the property or facility.
Using Cap Rate to Compare Investments
The good news is that there are tools available that make comparisons between potential real estate investments easier. One of these, which will become invaluable to you on your quest to make money from real estate is a special financial ratio called the capitalisation rate (cap rate). Cap rates show the rate of return on a commercial real estate investment. It takes its basis from the net income property will produce.
- The utility the property generates for its owner
- The net present cash flows it generates—relative to the price paid
Rental Income as a Margin of Safety
Rental income can be a margin of safety that protects you during economic downturns or collapses. Certain types of real estate investments are better suited for this purpose. Leases and rents can be relatively safe income.
Other Real Estate Investment Ideas
Still, other investment opportunities exist in real estate. You can invest in real estate investment trusts (REITs). REITs are shares traded on an exchange and can focus on particular sectors of the real estate market, such as nursing homes or shopping malls. There are also several exchange-traded funds (ETFs) and mutual funds that target the real estate investor.