Sunday, 16 February 2020

Making Money from Real Estate Investing

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 maximize their earnings. Real estate gives investors another portfolio asset class, increases diversification, and if approached correctly can limit risks.

There are three primary ways investors could potentially make money from real estate:

  • 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 years 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.

For example, if you own a $500,000 property and inflation is 3%, your property might sell for $515,000 ($500,000 x 1.03%), but you aren't any richer than you were last year. That is, you can still buy the same amount of milk, bread, cheese, oil, gasoline, and other commodities (true, cheese may be down this year and gasoline up, but your standard of living would remain roughly the same). The reason is that the $15,000 gain wasn't real. It was nominal and had no real impact because the increase was due to overall inflation.

Inflation and Real Estate Investing

When inflation happens a dollar 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 interest 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.

As inflation climbs, these investors can pay off the mortgages with dollars that are worth far less. This represents a transfer from savers to debtors. You saw a lot of real estate investors making money this way in the 1970s and early 1980s.7 Inflation was spiraling out of control until Paul Volcker Jr.—Federal Reserve president between 1979 and 1987—took a 2x4 to its back and brought it under control by drastically raising interest rates.

Cyclically Adjusted Cap Rate Purchases

  1. 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.
    For example, real estate developers can look at a project or development, the economic situation around that project, the price of the property and determine a future rental income to support the current valuation. The current value might otherwise appear too expensive based on present conditions surrounding the development. However, because they understand economics, market factors, and consumers these investors can see future profitability.
    You may have seen a terrible old hotel on a great piece of land get transformed into a bustling shopping center with office buildings pumping out considerable rents for the owner. Absent those cash flows, net present value, you are speculating to some degree or another, no matter what you tell yourself. You will require either substantial inflation in the nominal currency—if you're using debt to finance the purchase—to bail you out or some sort of low probability event to work out in your favor. 

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