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Making Money in Real Estate

We’ve all seen the late night commercials promising to teach you how to earn millions of dollars through real estate investments, but does it really work? How do people actually make money in real estate?

This tutorial doesn’t discuss specific investment strategies. The material presented here is designed to teach the reader the basic methods used to earn money in real estate. These techniques are time tested and have demonstrated effectiveness regardless of current market conditions.

Appreciation

Typically when real estate investments grow in value, they do it through appreciation. This can happen for a variety of factors, but the important thing to remember is this- appreciated value is only realized when a property is sold or refinanced.

Raw Land

One of the fastest ways to add value to raw, undeveloped property is to develop it. As populated areas grow and city limits stretch to surrounding areas, those property values go up thanks to basic supply and demand economics. When that property has been developed for residential or commercial uses, those values appreciate even more significantly.

Mineral rights can also play a key role in the appreciation of a property. Striking it rich by finding oil in one’s backyard is a good story for Hollywood, but even something as mundane as gravel can be extremely lucrative for a property owner.

Residential Property

Our parents taught us that we are judged by the company we keep, and this is also true for real estate. Location is a major factor in the appreciation of residential properties. Close proximity to schools, shopping centers, parks, and transportation can add value to residential real estate, just as the erosion of family friendly amenities will cut into property values.

A property owner can also directly influence appreciation by making improvements to the home. An extra bathroom, patio deck, swimming pool, or central air and heating are all investments that will add double or triple their expense to the value of a home. People who are in the business of ‘flipping’ houses (buying and selling quickly for profit) have learned to use improvements like this to maximize their investment return and turn properties around quickly, even in a tight market.

Commercial Property

Commercial real estate will appreciate for many of the same reasons as residential property, if not the same circumstances. Being located next to a large highway, train station, or a warehouse complex might be undesirable for a residential property, but those same factors might significantly increase the value of a commercial property. In addition to location, the amount of development on a plot of land can make it extremely attractive to businesses and investors.

Inflation

Property values also appreciate due to inflation, although there are important considerations to this. A property that sold for $10,000 in 1970, when adjusted for inflation, would sell for roughly $54,000 today. It would be a mistake to assume that the property value has increased fivefold, because prices for other goods and services have increased similarly.

Income

As we have seen, appreciation adds value to real estate, but these are effectively one time gains that will be realized when the property is sold or refinanced. Real estate can also generate ongoing income for a property owner.

Raw Land Income

Undeveloped land can create income through mineral rights and other natural resources that are present on the property. Businesses may pay royalties for mining, foresting, or drilling for oil, or may want to lease specific areas to construct buildings to assist with those operations.

Residential Land Income

Most commonly, residential property owners can earn income by renting to someone else. The landlord is still responsible for ongoing expenses like repairs and mortgage payments, a fact that came back to bite many people caught by plummeting values and who found themselves owing a higher monthly mortgage payment than they were taking in through rental fees.

Commercial Property Income

In addition to rental income, owners of commercial property can also earn income by selling specific, contracted rights. One of the most common ways to do this is with rights of first refusal on neighboring properties. Agreements like this provide excellent second revenue streams to rental properties, and have the added benefit of little to no cost for the owner.

What are REITs and MICs?

REITs (Real Estate Investment Trusts) and MICs (Mortgage Investment Corporations) allow individuals and organizations to earn real estate income without direct ownership. In an REIT, the owner sells minority shares in a property as a fund raising tool, and then distributes profits among the shareholders. This allows the primary owner to raise capital to finance new purchases, and allows investors to earn real estate income without the hassles of property management.

An MIC uses a private mortgage as an investment security, versus the physical property. These sorts of investments are much more abstract in nature, and are not necessarily impacted by changes to the property itself. Although they are based on real estate, they fall outside of the technical definition of a real estate investment.

Get Rich Quick Schemes

Generally, the types of schemes pitched in late night infomercials fall into these latter categories. One type of plan will involve owning the option to buy a particular property for a specific time period, and earnings are predicated on finding a buyer willing to pay more for the option. In other words, you are earning a matchmaker fee by connecting the actual property owner with a buyer. Prospective investors should exercise caution with “no money down” deals that promise quick returns. Known as OPM deals (shorthand for “Other People’s Money”), these are high risk strategies that yield minimal returns.

If It Sounds Too Good to be True

When you boil it all down, there are two basic ways to earn money in real estate- sell property for more than you paid for it, and via ongoing revenue streams through rentals and by leasing specific property rights. When considering an investment plan that goes outside of these strategies, it is appropriate to remember the Latin phrase “Caveat emptor” – let the buyer beware.

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