How You Make Money In Real Estate

Whether you’re curious about the investment potential of real estate

or simply sick of infomercials promising millions of dollars in

returns from a new and obscure way of investing in real estate, it is

worth learning how wealth is created through real estate.

Tutorial: Exploring Real Estate Investments

The most obvious source of appreciation for undeveloped land is, of

course, developing it. As cities expand, land outside the limits

becomes more and more valuable because of the potential for it to be

purchased by developers. Then developers build houses that raise that

value even further.

Appreciation in land can also come from discoveries of valuable

minerals or materials, provided that the buyer holds the rights. An

extreme example of this would be striking oil, but appreciation can

also come from gravel deposits, trees and so on.

*Residential Property*

When looking at residential properties, location is often the biggest

factor in appreciation. As the neighborhood around a home evolves,

adding transit routes, schools, shopping centers, playgrounds and so

on, the value climbs. Of course, this trend can also work in reverse,

with home values falling as a neighborhood decays.

Home improvements can also spur appreciation, and this is something a

property owner can directly control. Putting in a new bathroom,

upgrading to a heated garage and remodeling to an open concept kitchen

are just some of the ways a property owner may try to increase the

value of a home. Many of these techniques have been refined to

high-return fixes by property flippers who specialize in adding value

to a home in a short time.

*Commercial Property*

Commercial property gains value for the exact same reasons as the

previous two types: location, development and improvements. The best

commercial properties are in demand, and that drives the price up on

them.

*The Role of Inflation in Appreciation*

Of course, there is one major factor we skipped in our summary — the

economic impact of inflation. A 10% inflation of the dollar means that

your dollar can only buy about 90% of the same good the following

year, and that includes property. If a piece of land was worth

$100,000 in 1970, and it sat dormant, undeveloped and unloved, it

would still be worth many times more today. Because of runaway

Generally referred to as rent, income — or regular payments — from

real estate can come in many forms.

_Raw Land Income_

Depending on your rights to the land, companies may pay you royalties

for any discoveries or regular payments for any structures they add.

These include pump jacks, pipelines, gravel pits, access roads, cell

towers and so on. Raw land can also be rented for production, usually

agricultural production.

_Residential Property Income_

Although it is possible that you may earn income from the installation

of a cell tower or other structure, the vast majority of residential

property income comes in the form of basic rent. Your tenants pay a

fixed amount per month — and this will go up with inflation and demand

- and you take out your costs from it and claim the remaining portion

as rental income. While it is true that you will get an insurance

payout if your tenants burn down the place, the payout only covers the

cost of replacing what is lost and is not income in a real sense.

_Commercial Property Income_

Commercial properties can produce income from the aforementioned

sources — with basic rent again being the most common — but can also

add one more in the form of option income. Many commercial tenants

will pay fees for contractual options like the right of first refusal

on the office next door. These are essentially options that tenants

pay a premium to hold, whether they exercise them or not. Options

income is sometimes used for raw land and even residential property,

but they are far from common.

*What About REITs or MICs?*

Real estate investment trusts (REIT) and Mortgage Investment

Corporations (MIC) are generally considered to be great ways of

getting income from real estate. This is true, but only in the sense

that real estate is the underlying security. With a REIT, the owner of

multiple commercial properties sells shares to investors — usually to

fund the purchase of more properties — and then passes on the rental

income in the form of distribution. The REIT is the landlord for the

tenants (who pay rent), but the owners of the REIT get the income once

the expenses of running the buildings and the REIT are taken out.

MICs are even a further step removed, as they invest in private

mortgages rather than the underlying properties. MICs are different

from MBSs in that they hold entire mortgages and pass on the interest

from payments to investors, rather than securitizing the interest

streams independent of the original mortgage. Still, they are not so

much real estate investments as they are debt investments, and thus

outside of our area of interest.

*Smoke and Mirrors*

Similar to securities with real estate underlying the investment, most

of the alternative blow your mind with super fantastic return

methods are merely a layer on top of these two basic steams of income.

For example, there are informal residential real estate options where

you pay a fee to have the right to buy a house at a given time, say

after a month, for an agreed upon price. Then, you find investors who

Similarly, no money down or OPM deals are simply the financing aspect