Investing Talk #5: Real Estate Investing

Real estate investing means buying property to generate income, appreciation, or both. It's one of the oldest, most popular, and most flexible forms of investing — used by everyone from everyday savers to billionaires.

What Is Real Estate Investing?

It involves buying:

• Residential properties (homes, apartments)

• Commercial properties (offices, retail, warehouses)

• Land (raw or development-ready)

• Indirect assets (REITs, real estate funds)

To make money from:

• Rental income

• Value appreciation

• Tax advantages

 5 Popular Ways to Invest in Real Estate

 How You Make Money in Real Estate

1. Rental income: Monthly cash flow from tenants

2. Appreciation: Property increases in value over time

3. Tax benefits: Depreciation, mortgage interest deductions

4. Leverage: Using debt to buy more with less cash

5. Equity growth: Paying down mortgage builds net worth

Example: Rental Property

• Buy a $250,000 house

• Put down 20% = $50,000

• Rent it for $1,800/month

• Mortgage + expenses = $1,300/month

• Cash flow = $500/month

• Over time, property appreciates to $325,000

You earn rental income + equity + appreciation.

 Pros of Real Estate Investing

• Steady cash flow (from rentals)

• Appreciation potential

• Hedge against inflation

• Leverage lets you control more with less

• Tax advantages

 Cons and Risks

• Property management hassles

• High upfront cost (down payment, repairs)

• Illiquid (can’t sell quickly like stocks)

• Taxes and insurance costs

• Tenant risk (nonpayment, damage)

 Passive vs Active Strategies

 Key Questions Before You Start

• Do you want passive income or active involvement?

• Can you afford the upfront cost and maintenance?

• What’s your risk tolerance and time horizon?

• Are you more interested in cash flow or long-term appreciation?

Return on Real Estate Investment (ROI): What to Expect & How to Calculate It

Real estate can generate returns through:

1. Rental income (monthly cash flow)

2. Appreciation (value increase over time)

3. Loan principal reduction (you build equity by paying the mortgage)

4. Tax benefits (depreciation, deductions)

Basic ROI Formula

$$\text{ROI} = \frac{\text{Net Profit}}{\text{Total Investment}} \times 100$$

Where:

• Net Profit = Annual rental income – annual expenses + equity growth

• Total Investment = Down payment + closing costs + rehab

Example: Rental Property ROI

• Purchase Price: $250,000

• Down Payment (20%): $50,000

• Closing Costs & Repairs: $10,000

• Total Cash Invested: $60,000

 Income & Expenses (Annually):

• Rent: $1,800/month × 12 = $21,600

• Mortgage, insurance, taxes, maintenance: $15,000/year

• Net Cash Flow: $6,600/year

• Appreciation (average 3%/yr): $7,500

• Loan principal paid off (year 1): $3,000

• Total return: $6,600 + $7,500 + $3,000 = $17,100

 ROI:

$$\text{ROI} = \frac{17,100}{60,000} \times 100 = \boxed{28.5\%}$$

This is leveraged ROI — enhanced by using a mortgage. Unleveraged ROI would be lower but safer.

 Typical Annual Return Ranges

Note: Returns vary by market, property type, and how actively you manage it.

 What Affects ROI?

• Leverage: Mortgages increase ROI if rent covers costs

• Repairs and CapEx: Unexpected expenses cut into profits

• Location: Strong job markets & population growth = higher returns

• Vacancy rates: Empty properties earn $0

• Holding period: Longer holds benefit from compounding appreciation

 Bonus: Cash-on-Cash Return (COC)

$$\text{COC} = \frac{\text{Annual Cash Flow}}{\text{Cash Invested}} \times 100$$

• Great for comparing income-generating properties

• Doesn’t include appreciation or loan payoff