This is petty much real estate investing 101 but it’s good to go back over the basics occasionally. If you invest wisely, your first increase in wealth should occur as soon as you sign the closing paperwork. If you buy a $100,000 house for 80% if market value, you should be worth $20,000 more as soon as the deal closes.
Cash Flow and Equity Growth
While you own the house, most of your increase in wealth will come from positive cash flow. If your positive cash flow is $200 per month after all of your expenses are covered, that comes to $2,400 a year. If you hold the investment house for 10 years, your positive cash flow totals $24,000.
If the house appreciates at an average rate of 7% per year and inflation is 2.5% a year, your actual equity growth is 4.5% per year (7% – 2.5%). The $100,000 property will appreciate to a value of $210,485 (compounded annually) over 10 years. Another increase in your wealth of $120,485 (210,485 – 90,000).
The equity growth however is not without risk. One risk happens when investing in a small rural town that is heavily dependent on a single employer. If that employer goes out of business, the entire town can become a ghost town wiping out the value of anyone owning real estate in the town and surrounding areas.
Debt Pay Down
Of course, the third typical way of accumulating wealth through real estate investing is by paying down the debt used to finance the investment. With each passing month that you use renter’s cash to pay down your debt, the portion of the investment that you own debt free increases. Assuming you finance the entire purchase price of $80,000 at 5% interest on a 30 year loan, your outstanding balance after 10 years will be $65,074. Your wealth will have increased another $14,926. Here is how all of the numbers add up for that 10 year period:
At closing $20,000
Cash flow $24,000
Debt pay down $14,926
That’s a darn good return if you financed the entire deal without putting any of your own money in. Of course, you’ll probably need to put some money down but even if you invest $10,000 that’s still a very handsome return on your money.
You don’t have to wait ten years to get all of your money out of the deal. The $200 in cash flow is coming to you every month. The growth in appreciation and pay down of debt are occurring over time. You can borrow against these sources of your wealth to invest in other properties or do with it as you want.
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Author bio: Brian Kline has been investing in real estate for more than 30 years and writing about real estate investing for seven years. He also draws upon 25 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, a few short miles from a national forest in the Olympic Mountains with the Pacific Ocean a couple of miles in the opposite direction.