Why real estate is one of the best ways to make money

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Why real estate is one of the best ways to make money

Every other Monday on Make Money Your Way, we will talk about how to make money with real estate. Today as an introduction I want to show you why I think real estate is one of the best ways to make money and build wealth.

 

There are many ways to turn a profit with real estate.

 

When you buy a stock, the only way you can make money is if the stock appreciates in value, and you sell it at the good time. With real estate you can make money in many ways, I can name those 12 off the top of my head, and there are many more.

Rental income. That one is the main source of profit investors are going for when buying a rental, and doesn’t need an explanation.

Buying low. You turn an instant profit if you manage to buy a property for under market value. Think foreclosures, quick sales, and awesome negotiation skills.

Selling high. You can make extra money if you stage the property to attract buyers over market value. With stocks, you always buy and sell at market value. With real estate, you can try to beat the market.

Increasing equity. If you take a mortgage to finance a rental, you are increasing your equity with every mortgage payment. I put down 25% on my last rental and with mortgage repayments am around 33% equity at the moment, those 8% of the property value were paid by rents and are increasing my net worth every month.

Leverage increases returns. If you put 20% down on a property, you will still receive rental income based on 100% of the property value, making it a great return for your 20%. Say your property is worth $100,000 and you charge $750 in rent with $500 in mortgage, taxes and fees. You have a $250 profit on $20,000 down. That is $3,000 a year, or a cool 15% return on your deposit. Good luck trying to get an almost guaranteed 15% on stocks.

Leverage makes you profit on the full selling price. If that same $100,000 property you bought with $20,000 down sells for $120,000 a few years later, you get your $20,000 plus principal payments back, and a $20,000 profit. It is only a 20% profit over the full value of the property, but thanks to your leverage, you are making a profit of 100%, minus principal payments to the $80,000 mortgage. The bigger the leverage, the greater the return.

Renting smaller units. I rent three rooms by the room, to three tenants. I can charge more than if one family was renting the whole place. You can divide your family house into a duplex or a triplex and increase the rent.

Renting to businesses. Businesses are a different type of tenure and rents are generally higher. They are also safer if you choose a well known business to rent to.

Tax benefits on interest. Depending on your country of residence, you can often deduce the mortgage interest from the rental income, and create a tax free profit.

Tax benefits on improvements. You can also deduce the cost of the improvements from the rental income, while the added value to the property is yours to keep.

Profit from a lump sum on a refinance. So you bought your $100,000 place, and put $10,000 worth of improvements, that the tenants paid back with rents. The property is now worth $125,000 because your contractor did a great job, you can refinance to get the $25,000 cash and put 25% down on your next $100,000 rental!

Profit from extra cash flow on a refinance. If you are able to refinance the property to lower your mortgage payments while the rent stays the same, you are generating more cash flow every month. You can build a cushion for maintenance, save up for a deposit on a new rental, or have more passive income to live off.

 

 

There is less risk in real estate leverage than in stock leverage

 

Stocks are volatile. Penny stocks and currencies even more so. Some trading companies will allow you to trade on leverage. That means if you buy 1,000,000 shares of a penny stock valued at $0.05, the trading company will not require that you fund your account with the full $50,000, it will let you buy the shares with only $5,000, BUT if the share goes down to $0.045, which it almost certainly will, you will get a margin call and your whole account balance will be wiped out.

With real estate, you can put the same $5,000 as a deposit on a $50,000 or even a $100,000 house, and rent it. If you have a renter, you don’t really care about the ups and downs of the market, as you are able to meet your monthly repayments. If the property sits empty for a while, all you have to do to keep it is pay the mortgage yourself. It isn’t fun, but it is much better than seeing your whole trading account annihilated by a margin call.

 

 

Real estate is what you do with it

 

I bought my first rental cash when I was 22, let the property rot and did not invest a dime in repairs in 10 years. The result? A low rent and quite a bad tenant. He was there before I bought the place and I wanted to have him out before renovating, but he beat me to the game, stayed for 10 years, died, I had to evict his widow, and managed to sell the place a few months later for double the money.

 

My last rental is a different story. I bought a brand new property, furnished it nicely, set up rental prices that are not outrageous but will drive away the worst tenants, and positions the place as an upscale flatshare for young professionals, instead of a bottom range share for first year students.

 

What you plan on doing with the property should determine the area you buy in, the type of unit you buy, the state of the property, and all details about said property. If you are not handy and hate to renovate, buy a new place or somewhere you can afford to hire out the renovation without tanking your operation. If you want to rent to families only, buy a nice family home in a good school district. For young professionals, find an affordable studio or 1 bed that is an easy commute from a dynamic zone of employment.

 

The same thing applies to managing the place yourself or not. Property managers will happily do the job for a fee, and if you are busy, that fee will be worth your time and then some. It will however decrease your profit. Choose to do it yourself, and you will have all sorts of headaches, and a source of income you can no longer call passive.

 

How you profit from real estate depends on YOU. When you buy a stock, you never know, for as much as you study the company, if its CEO isn’t about to leave and the next one will run the company to the ground, if there is a merger with a less profitable company in the pipeline, or if an earthquake will destroy the production plant in China. Your real estate investment will be a result of your own efforts to renovate a place, promote it, screen a proper tenant, and keep it up over the years. And real estate is tangible. When all the markets tank, you are trying to hold to your losing positions in hopes they will go up in a few months, or hurrying to sell at a loss before it gets worse. Real estate will bring you a monthly rent to cover the mortgage, even if you have negative equity. And in periods of economic turmoil, when people lose their houses to foreclosure or first time buyers are denied mortgages by the banks, you will have more potential renters than ever. When things go back to normal, home prices will increase and you can make a nice exit, sit it out until the next crisis, and go back in the game to buy low. Don’t want to time the market? Just buy. Now is as good a time as any, for all the reasons mentioned above.

 

What are your thoughts about real estate?

 

This post was featured on the Making Sense of Cents, Girls Just Wanna Have Funds, Your Daily Finance, Control Your Cash, Fat Guy Skinny Wallet, Frugal Rules, Modest Money,  Aspiring Blogger, Money Bulldog, thank you!


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About Pauline

A 30 something French girl looking for ways to make more money. I blog about real estate, side hustles, improving your career, investing and making money online.

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Comments

  1. I’ve found that real estate is incredibly location specific. In some areas you’ll be able to pretty easily pick up a property and start getting rental income. In others you’ll have to hunt for short sales and fixer uppers.

    Real estate can be considered risky in that it commits a huge amount of money and associated leverage to a relatively illiquid asset. So if you make a mistake, it could wind up costing you a lot

    Finally, real estate overlaps a lot with entrepreneurship. If screening tenants, responding to maintenance calls, or chasing down owed rent doesn’t appeal to you, you either have to pay extra for a property manager or rethink being a landlord.
    My Financial Independence Journey recently posted…Weekend Link LoveMy Profile

    • True, you have to be there or pay someone. My solution with my UK rental has been to put the rents a bit lower but offer a great place so I get dozens of applicants and screen the very best, the guys are paying on time, they take care of the place, try to DIY before calling a plumber, etc. It saves me the 15% admin fee.

  2. We would LOVE to get into real estate investing one day. We’re a bit worried about renting, simply because my dad has had some terrible, destructive renters, but all in all I think it’s a terrific investment.
    Laurie @thefrugalfarmer recently posted…June Recap – Happy 6 month Anniversary and the Three-Legged GoatMy Profile

    • You have to screen them carefully! My first tenant was already in on the first rental I bought and he was bad. Now I screen and they are ok.

  3. I am just starting my journey into real estate so Pauline this really comes in handy. What I am finding though in my area is that you better have connections because the best deals never make it to the ads. Short sales and foreclosures seem like the best options but it also like you mention could require a lot of work and money up front. Not sure it that is best since if you lose could stand to lose 20k easily. Guess no risk no reward but needs to be calculated. I like the idea of buying and renting per room but with that you have the problem of always needing to find tenants as they maybe be just there for short leases. Families tend to not want to move. But rent by room does allow for higher rates almost like a duplex or triplex.
    Thomas | Your Daily Finance recently posted…June Stats, Updates, Goals, and Future PlansMy Profile

    • Families staying for years allow you to increase rents 2 or 3% a year. The rent per room, I have had two tenants stay for 3 years, the other are generally at least 6 months but one stayed 2 months. In September I get the students, in February the foreign students on exchange, in summer, the PhDs and searchers, and all year since it has also big companies’ headquarters (Colgate, Nokia, Honeywell…) I get young professionals. But you have to choose your location carefully.

  4. We rent part of our house and we definitely see our house as a good long-term investment. I like real estate, but I do think that it can be volatile and is a lot less liquid; you can’t jump in and out as easily as the stock market.

    This is a great post and I had a real estate post planned for a couple weeks from now. I will definitely try to remember to link to your post!
    DC @ Young Adult Money recently posted…Want to be Wealthy? Own SomethingMy Profile

    • thanks! Real estate is less liquid, but in the meanwhile you get rent, and since it is rent on your deposit, it is generally a bigger return than dividends. If stocks tank, you can sell at a loss or may have to wait 3 years to sell. Same with real estate, lower your price by 30% and you’ll get a seller today.

  5. I like that stocks have a far smaller outlay than housing and are more liquid so that I can get my money out ASAP if needed. Having said that, I do want to own a rental property one day as I feel it is a more stable longer term investment.
    Glen @ Monster Piggy Bank recently posted…The Best Penny Stocks I Have OwnedMy Profile

    • get your money asap if you are not losing! or at a loss. You should be able to get your money in a month with real estate too if you are ready to take a loss or sell under market.

  6. I definitely agree that real estate can be a great place to invest and would be interested in getting involved in it some day. But I don’t think the comparison above is totally fair. You can make money in stocks from dividends in addition to capital gains (though I’m not one of those people who chooses to focus primarily on dividends, they’re still a big part of the return). Also, some of the things you mention as advantages for real estate such as being able to sell for a gain or buy on sale also apply to stocks. As for the point about increasing equity, that’s only true because you’re using debt, which you can also do with stocks and may work to your advantage or disadvantage in either case. I would argue that it’s largely an advantage if you can avoid the debt and own 100% outright, as is much easier to do with stocks. And I would also argue that owning a single rental property, or even a few, while potentially profitable is very undiversified. You can diversify your real estate holdings with REITs, but that’s not really what you’re talking about here. Buying a good stock index will immediately diversify your holdings, give you 100% equity and give you the opportunity for both dividends and capital gains.

    Anyways, I don’t disagree with you about real estate being a potentially good investment. I just think the comparison could be made more fair.
    Matt Becker recently posted…Stop Focusing on the Negatives. Start Enjoying Life.My Profile

    • Leverage is much more dangerous on stocks as you can get a margin call and stocks can lose value from one day to the other while RE gets slower reactions to the economic events. Yes it is not diversified to buy 1 rental instead of $100,000 worth of index funds, but with funds you may be at a loss for 3 years and refuse to sell while with RE you can have negative equity and rent will still kick in.

      • I’ll agree on the leverage point, but your second point is again ignoring the reality of dividends, which operate very similarly to rent. It may not be as high an amount, but it’s still regular income coming in regardless of the current value of the stocks and the potential for growth is much higher. And another consideration is costs, which will be much higher with a rental unit than with a simple stock index fund. Not to mention the work involved, which will again be greater with a rental unit.
        Matt Becker recently posted…Stop Focusing on the Negatives. Start Enjoying Life.My Profile

      • I do not fully agree that leverage is more dangerous on stock. Of course margin calls are dangerous if the correlation of portfolio is too high, forcing you to sell at a loss while every holding is down at the same time. but it’s not the only way to use leverage. As an example, you could purchase an out of the money call option that expires shortly after pending big news for a stock, this way your downside is limited to the option premium while upside is unlimited. (asymmetric returns in situations like : biotech new drug approval, tech company sales report of new product, O&G exploration company drilling results, turnaround stories, etc.) I think the reason that real estate seems safer is just because prices move more slowly.

        Also, concerning buying low and selling high, it’s not harder to do in stocks when someone is patient, using unmarketable limit orders, taking advantage of labor holidays differences for inter-listed stocks as well as low volume periods during the trading day. I guess it’s mostly a question of picking stocks that are below the radar of HFT firms. Just like finding an hidden gem in real estate before a listing agency.

        Finally, a big advantage of stocks for me is that they’re easier to analyse and compare. Every share of a corporation is worth exactly the same, while 2 neighboring houses or 2 houses build from the same plans could have a huge value difference. I still plan to invest in RE, but based on realistic return assumptions instead of simplistic arguments.

        • You are right, if used properly, leverage can work with stocks too. Although you would rarely put the price of a house on one stock, so you have to do your study for all the stocks you pick, meaning it can be more work than RE. Buy and hold for the long term is more passive than real estate indeed.

    • Matt,

      Great points. I tend to agree with you. I look at investing in stocks as much less risky than real estate, but that’s probably just because I don’t have any real estate experience short of buying a home.
      Derek @ MoneyAhoy.com recently posted…My June 2013 Money Making, Saving, and Investing ReportMy Profile

      • For the beginner investor, investing $100 a month into index funds is probably the best way to start getting a return for his money. If you don’t know what you are doing, just like investing with a 1:50 leverage in penny stocks, buying a rental whose rent you are unable to cover if empty, and that just allows to pay the mortgage but no maintenance is a crazy gamble. You’ll hit foreclosure at the first hiccup. But like stocks where you can get an easy out at a big loss, with RE you just have to be ready to take that loss to and you can exit quickly.

  7. Nice post Pauline! I want to get into real estate at some point, but just do not have the time to devote to it right now. I think it’s a great way to bring further diversification to your investing as well as create an income stream.
    John S @ Frugal Rules recently posted…In the Blink of an EyeMy Profile

    • If you find the right property, you can manage it effortlessly with an agency, or look at REITs, it doesn’t have to be that time consuming.

  8. I think real estate is a lot less of an investment these days than it used to be, but I think it will come back. The economy in the US caused the property values to plummet and keeping those as rentals could be wise, but your cash is stuck in a devalued asset. As DC indicated, having your money tied up in an asset that is hard to get out of can be very risky these days.
    Debt Roundup recently posted…Are You Hardwired To Make Bad Investment Decisions?My Profile

    • I think on the contrary, you should buy some more if property prices are low, because rental prices will be sustained by people who lost their houses and those who can’t afford to become homeowners. Sure you tie up cash but when the stock market plummets you can also either sell and lose or have to hold for the long term.

  9. We love investing in real estate because we can see it and feel it in a way that you can’t do with traditional investments. I don’t necessarily think of my own home as an investment since we live in it, but I love owning rental properties because all of the benefits that come with it!
    Holly@ClubThrifty recently posted…Forrest Fenn: An InterviewMy Profile

  10. This is DEFINITELY on our to do list. I’m super excited about the possibility!!
    Keren recently posted…July 2013 GoalsMy Profile

  11. Pauline,

    I’m with you 100%.

    I started buying fixer upper houses 11 years ago and it was one of the best decsions I ever made.
    Terry recently posted…“Turn Your Home into a Rental House” to be topic on “The Morning Blend”My Profile

    • I’d love to start doing that, I have no eye for nice details, but hopefully could still make it work with a reasonable contractor.

  12. Real estate is a great investment in our area because prices are low right now. but rents are pretty high. One of the best things I ever did was buy part of my commercial building. I know the rent will be paid, because it’s to myself. When I sell the business, the buyer will become my tenant, so it’s a win win, but I can see how a commercial property would be tough in some markets. I also like that I can drive up and see what I own. It somehow feels more real than looking at fund balance.
    Kim@Eyesonthedollar recently posted…Common Credit Card Mistakes To AvoidMy Profile

  13. I love real estate and all of the opportunities it provides, but it can be very dangerous. I agree with all of your points above, but I’m not sure that I’d leverage myself too much just because of the possible downfalls. That being said, it can be a good strategy.
    Jake @ Common Cents Wealth recently posted…How Much Do Fuel Efficient Cars Really Save You?My Profile

    • You have to be very comfortable with the repayment in case the property stays empty for a while. You could either have 6 months worth of mortgage in cash, or know that you can cover it with your salary… otherwise at the first vacancy you’ll get foreclosed. Leverage is great when used properly but very dangerous.

  14. Pauline, there are many ways that we are considering investing and you make a good argument for real estate here. The enormous amount of capital upfront is the only daunting aspect. Would you consider it for beginners or perhaps something less risky and less expensive? Ah, this is such fun to ponder. Never thought we’d find ourselves in such a position!!! Ha!
    cj recently posted…Why I No Longer Eat CheeseburgersMy Profile

  15. Well I think it’s tough in my area because I can’t afford anything here, and feel somewhat nervous about having a rental property out of state…especially when I have never done it before! But I think it’s something that’s a possibility in the future!
    Budget and the Beach recently posted…The Apartment: What Would You Do?My Profile

    • There are a few bloggers who explain how they manage out of state rentals, if the rent yields enough to cover a manager it is pretty hands free. But I’d always try to get a place where I could live myself in case it sits empty for too long.

  16. Wow, it sounds like you are a real estate ace!

    I’d love to get into real estate, but I need to learn more about the ins and outs of things. It doesn’t sound that hard if you’re willing to put the time into it!
    Derek @ MoneyAhoy.com recently posted…How to Setup a Blog for Fun or ProfitMy Profile

    • I am not a pro but I enjoy it and have had good result so far. You have to buy carefully, like you would a stock and then be ready to put in a little time to manage but otherwise it is pretty straightforward.

  17. Ok, Pauline. I have to say that – although we can in no way DIY with fix-ups and the like, I can say that I would consider investing in real estate. I will have to check out that article you mentioned above! Thank you!
    Tammy R recently posted…Just Can’t Keep It to ThemselvesMy Profile

  18. I am a huge fan of real estate. Over the years, it has provided the nitty gritty foundation of my portfolio. The beauty of real estate is in the leveraging. The fact that it is a hard asset is also a big plus.
    But, even so, you will never have to redo a roof on a stock holding. A sewer backup will never compromise dividend payouts. And a revenue property will never provide you with a two for one or a three for two split. Ultimately, no matter what your favorite asset class happens to be, diversification is the name of the game.

  19. I would love to make money with real estate but around here it’s just not as easy.
    SuburbanFinance recently posted…New Wireless Company Code of Conduct for CanadiansMy Profile

    • When I invested in the UK it was a similar market to yours, high prices and quite low rental yields. Splitting the property into three rental contracts by the room helped have a positive cash flow, and even if you break even on cash flow you still get a property paid by your tenants in 20 or 30 years.

  20. Huge fan of real estate. I started with a savings account. Gradually moved into index funds, stocks, etc. Once I started real estate, the lightbulb really turned ON on how to make money. Makes too much sense not to do. I always encourage everyone who is serious about building wealth to get started investing in rental property ASAP.

    Wow, you purchased your first rental at only 22!
    FI Fighter recently posted…I’m 28 Years Old, Control $1,000,000+ in Assets, and am $578,740.76 in Good Debt!My Profile

  21. I didn’t see one of the best advantages of RE listed – depreciation expense. For aggressive investors, you can document the fixtures/stuff IN the house (called chattel) and depreciate if much faster than the house itself. The chattel can be depreciated in a 3-5 year time frame, I believe, vs. the 27ish year depreciation schedule for the house. I have videotaped houses I’ve bought to keep a record of the flooring, bath and kitchen fixtures, appliances, cabinetry, blinds, EVERYTHING, assigned a fair value to it, and depreciated it pronto.

  22. Real estate is one of the best business for getting profits, but there are many of fluctuations are there in this business. The thing is to be knowing the important issues regarding that business.
    Chris Marwon recently posted…Tips For Upgrading Your ThermostatMy Profile

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  26. I like real estate investing because 1) Working Class Neighborhoods are Ripe For The Picking, offering the BEST cashflow, from properties priced under 30k!
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  30. Pauline,

    In general well said. I would say that investing directly in real estate isn’t for everyone. You have to be willing to put in a lot of time, e.g. “sweat equity”, as well as get your hands dirty fixing appliance and meeting with contractors. So if you’re not into that kind labor, go with a REIT.

    Thanks,

    James

  31. I definitely agree with you on this since you’ve pretty much sum it all up. And how you profit from real estate really depends on you. It may not be for everyone but withthe proper perspective it may grow on to be a good business.
    Lauren Hannah recently posted…North Susana Executive VillageMy Profile

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