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Real estate investing is a numbers game and the purpose of this newsletter is to show you how ‘to do the numbers’.
The prudent investor seeks a return on investment. To achieve that return, he or she has to look at the numbers carefully. At the current financial data and at reasonable projections of how the investment will perform in the future.
Begin your study of the concepts and calculations just as you would if you were building a new house. Start with the foundations: the four basic investment returns. They are the ways you make money with real estate investments, with income property.
Not every income-property investment will provide these returns in equal measure. Each property is unique and will blend the four benefits differently.
Today we put the lights on one of the most important concepts of real investment: cash flow.
It’s quite simple actually. If an income-property, a property you rent out to a tenant, generates more income than there goes out (tax bills, repairs, mortgages, etc.) you have positive cash flow, meaning you are making money.
On the contrary, when you have more costs than the cash that comes in, you have a negative cash flow. If you have a negative cash flow, then you have to put money in that comes from another source, perhaps your savings.
minus cash OUT
= cash flow
For example, you own an apartment that you rent out for 1000€ a month and is always occupied. You pay a mortgage of 600€ per month, an IBI property tax bill of 300€ per year and 900€ per year for repairs, and insurance of 300€ annually. The monthly quote as a member of the community of property owners in the building is 50€.
rent income: 12 x 1000 = 12000
mortgage: 600 x 12 = 7200
the community of owners: 600
Total cash out: 9300
Positive cash flow of 12000 – 9300 = 2700€
This is of course the cash flow before paying taxes. Tax control is a major part of real estate investing and something we will look into in detail in a separate session. Taxpayers can deduct in their personal income tax all the expenses that are necessary to obtain the income from a rental property.
You should note that the source of cash inflows and cash outflows doesn’t concern you when calculating cash flow. The important thing is that you know, that you make projections based on real numbers.
Let’s say for a moment you used 60.000€ of your savings to purchase the property and that all the rest was financed with the mortgage. This means your savings have a 2700 / 60.000 = 4,50% return.
Compare this to how much interest you would have received from putting 60k on the bank. Almost nothing?
But there is even more value to find in your investment. If one day, you would like to sell this property, the odds are you will sell it for (much) more then you bought it for. This is called appreciation, the second way of making money with real estate investing.
Next week more about this: appreciation, the growth in value of a property over time.