People invest in real estate for many reasons. One of the main reasons is for profit. Profit can be generated through what we call cash flow, appreciation, tax benefits, and principal reduction or mortgage paydown. While there are four main reasons people tend to invest in real estate for financial purposes, they usually buy the property with the intent to make money off the cash flow, the appreciation, or both.
Cash flow is basically the difference between what you make on the property and what it costs you. So, for example, if you rent a property out to your tenant for $1,500 per month, your cash flow is not necessarily $1,500. You’d have to subtract any mortgage payments, taxes, interest, insurance as well as any expenses you incur that are associated with the property like property management fees, landscaping, utilities, etc. Then whatever is left over is your cash flow.
With appreciation, this happens over time. People will buy a property, hold on to it for years with the intent for it to go up in value over time and reap the benefits of the financial gain of positive equity. At that point, they may sell the property, tap into the equity to buy more properties, and so on.
While it sometimes makes sense to buy a property that you foresee appreciating over time based on the real estate market in that particular area, it is a bit risky. If a property goes down in value, you risk the financial gain of appreciation. However, you may be able to take advantage of the depreciating asset when it comes to your taxes.
Now, if you buy the property for cash flow and it does go down in value, or depreciate, the fortunate thing is you can still make money on that cash flow. But if you buy for appreciation and it goes down in value, you may be upside down in the property, which means you owe more on the property than what it’s worth.
In any case, knowing why you’re buying the property and your exit strategy will help minimize the risks associated with investing in real estate. The more you know, the more money you can potentially make and the safer you may be able to invest.
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