Property value increases and rental income are just two ways to profit
Reviewed by Somer AndersonFact checked by Katrina Munichiello
Many investors know the potential of real estate wealth. Rather than providing vague methods for investing in real estate or a primer on homeownership for first-time buyers, this article will analyze proven strategies and how to look for timely opportunities.
Key Takeaways
- The most common way to make money in real estate is through appreciation, an increase in the property’s value.
- Location, development, and improvements determine real estate appreciation.
- Real estate investors commonly rely on income from rents for residential and commercial properties.
- Real estate investment trusts (REITs), mortgage-backed securities (MBSs), mortgage investment corporations (MICs), and real estate investment groups (REIGs) are investment alternatives within the real estate sector.
Emily Roberts © Investopedia 2019
Profits and Property Value
When real estate appreciates, it increases in value. Investors commonly earn a profit when they sell. However, property owners can increase their return on investment on a property by refinancing the loan at lower interest. This will lower the cost basis for the property, thus increasing the amount that they clear from it.
The appreciation for undeveloped land is achieved by developing it. Once developers build houses or commercial buildings, it raises the value. Appreciation in land can also come from discoveries of valuable minerals or other commodities—provided that the buyer holds the rights to them. Commercial property gains value for the same reasons as raw land and residential real estate: location, development, and improvements.
For residential properties, location is often the biggest factor in appreciation. As the neighborhood around a home evolves, adding transit routes, schools, shopping centers, playgrounds, and more, these changes cause the home’s value to climb. Of course, this trend can also work in reverse, with home values falling as a neighborhood decays. Home improvements, such as adding an extra bathroom or remodeling a kitchen, may increase the value of a home.
Warning
Real estate investors must consider the economic impact of inflation. While inflation can lead to appreciation, it is a bit of a Pyrrhic victory. A property owner may get five times their money due to inflation when they sell, but many other goods cost five times as much to buy, too, so purchasing power is a factor.
Real Estate Income
- Raw Land Income: Companies may pay real estate owners royalties for any discoveries or regular payments for any structures they add. This may include pump jacks, pipelines, gravel pits, access roads, and cell towers. Raw land can also be rented for agricultural production.
- Residential Rent: Residential property income comes as rent where tenants pay a fixed monthly rate. A desirable location is critical for owners to secure tenants easily.
- Commercial Property Income: Commercial properties also earn income through rental payments. Many commercial tenants may also pay fees for contractual options like the right of first refusal on the office next door. Tenants pay a premium to hold these options, whether they exercise them or not.
Buying and Selling Strategies
- Buy and Hold: Many real estate investors buy a single-family home and rent it out or buy a multifamily home and live in one of the units while renting the others to cover the mortgage. Buyers can choose to manage the property or hire a management company.
- Flipping: Property flippers specialize in adding high-return fixes to houses in a short time and then selling them. Flipping can be lucrative for those who find the right properties to fix.
- Vacation Rentals: When there is demand for home-away-from-home rentals, homeowners can earn income by renting out a house or even just a room on a short-term basis, especially if the property is in an area that’s a well-known tourist destination. Local bylaws commonly dictate the rules for listing a property on Airbnb, Vrbo, or HomeAway.
Important
New rules for the National Association of Realtors, expected to take effect in July 2024, may lower commissions for home buyers and sellers. If a federal court approves the changes, the standard 6% commission ends and sellers no longer have to propose compensation to prospective buyers and their agents. NAR will also require brokers to enter into written agreements with their buyers to help consumers understand what services will be provided, and at what cost.
Other Real Estate Income Sources
- REITs: Real estate investment trusts (REITs) allow investors to buy shares of a fund of multiple commercial properties with the rental income shared as a distribution. The REIT is the landlord for the tenants, but the owners of the REIT record income once the expenses of operating the buildings and the REIT are taken out. There’s a special method for assessing a REIT.
- Mortgage Investment Corporations (MICs), Real Estate Investment Groups (REIGs), and Mortgage-Backed Securities (MBSs): These invest in private mortgages rather than the underlying properties. MICs differ from MBSs in that they hold entire mortgages and pass on the interest from payments to investors. REIGs are usually private investments with a unique structuring, offering investors equity investments or partnership servicing.
Alternative Investments
An informal residential real estate option requires investors to pay a fee, or premium, to have the right to buy a house for a specified period for an agreed-upon price. The premium is essentially a finder’s fee for matching a person looking for an investment with a person looking to sell.
Short sales involve purchasing a home from a lender when the mortgagee is behind on payments. Short sales can be a time-consuming and complicated proposition. Lease options allow investors to lease with an option to buy. Contract flipping involves the transfer of the rights of a purchase contract to another buyer and pairing distressed sellers with motivated buyers.
Is Real Estate Investment Always Profitable?
Real estate investment is not a sure bet. The real estate market has boom and bust cycles, and real estate investors can lose and make money.
What Is a Common Way to Profit in Real Estate?
The most common way to make money in real estate is through appreciation—an increase in the property’s value realized when they sell.
How Do Investors Find Properties for Sale?
A realtor or real estate professional can help investors find properties. Online sites such as Zillow or Redfin also list properties for sale.
The Bottom Line
There are several proven strategies for making money in real estate. Appreciation and income rank high, but several alternative real estate investments exist. Real estate investors should consider the costs and risks associated with buying properties.
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