How to Make Money in Residential Real Estate: Part One
While most people can realize a profit by buying then selling a home, whether they live in it for a while or simply ‘flip’ it, there is tremendous income potential when you invest in residential real estate as a rental property. Read on to discover how to make money in residential real estate.
How to Make Money in Residential Real Estate
Choosing the right rental property
Investing in a rental property guarantees you income in two important ways – monthly rental payments and appreciation, the increased sale price of the property over time. By starting with a clean, solid property in a favorable location, inflation and demand will drive up the rental fees you can charge. The increased rent over time allows for more cash flow that can help by paying off the principle faster or you may choose to improve property thus increasing the selling price.
Determine your Cap Rate
In terms of rental income, the cap rate is the annual expected return on your investment. It is relatively simple to figure out:
- Estimate the total rent you expect to receive in one year.
- Determine the costs of owning the property including real estate taxes, insurance, repair costs and utilities that you (not the tenant) may have to pay.
- Subtract the costs from the anticipated rent and determine the percentage of the difference.
For example, if you have an $100,000 dollar property, and the annual return over one year is $10,000 net after expenses, then you have a 10% CAP Rate.
The higher the percentage of income, the higher the cap rate and that means more return on your investment. You can ‘pick’ your percentage and work to find a property that will provide that cap rate just like you can invest in a particular stock for its proven returns. Unlike stocks, however, you will still own the property and will always have the equity.
For example, if you have a property generating $20,000 in income a year, then you can offer $200,000 for the purchase price. Then you will have a CAP Rate or annual return of 10.
Single family vs. multi-family homes
Pros and cons are part of any decision, and your choice depends on your needs and goals. In any real estate purchase, it is important to start with prime properties that are priced right. Location is a key factor as is the general condition of the neighborhood and availability of good schools and transportation. Choosing a property in a good location in a mid-price range is the best beginning for positive appreciation in value.
Pros for single family homes:
- Single family homes require less principle investment than a larger property. A larger investment ensures a greater cash flow as the principle can be paid down faster and a lower loan percentage rate may apply.
- Single family homes may attract tenants who will stay longer and appreciate the ‘home’ feeling of the property.
- You can buy and live in the home (for the last two years) while making some improvements and reduce your capital gains tax burden when you sell.
Pros for multi-unit properties:
- Multi-unit properties are great for long term investing because of appreciation and increasing rental fees.
- You can live in one unit while collecting rent from the others and realize a better cap rate.
Property is real and serves a necessary function – providing shelter. For that reason, owning property is a great hedge against possible down-turns in the economy because it is something that someone will always need. Investing in residential real estate may be a gamble, but the potential for a significant return on investment makes it one of the most profitable of all investment options.
Looking for advice on how to make money in residential real estate? For complete, friendly service to help make your real estate transactions smooth and profitable, contact Derek Worchel at Keller Williams Western Realty, serving Blaine, Lynden, Bellingham and Ferndale, where professional experience means professional results.