5 Ways a Rental Property Makes Money (And How You Can Do it All)
A common notion amongst landlords is that making money off rental properties is all about collecting monthly rental checks. Well, that’s partly true, but it’s not the whole story.
While consistent cash flow from tenants is undoubtedly essential, there are more ways your rental property can bring in money and boost your profits.
In this article, we’ll help you expand your knowledge on how rental properties make money and what you can do to take advantage of them all.
#1 Cash Flow
Positive monthly cash flow is the primary way to make money renting houses. Your net cash flow is the difference between the yearly rent collected and all operating expenses. Therefore, a positive cash flow means you have excess income after deducting all expenses.
The five common operating expenses that landlords pay are the following:
- Vacancy: When your property has no tenants, commonly during time in-between tenants, your property becomes an expense, as it’s not earning anything.
- Repairs: Repairs and maintenance work for items like faucets, appliances, light fixtures, HVAC repairs, doors, and locks will cost you. The larger the size or the older the condition of your property, the higher the costs will be.
- Management fees: Whether you work with a property manager or not, you have to consider the cost of managing. This fee can either be in the form of actual payments to third-party help, or the time it takes you to self-manage your properties.
- Delinquency: Delinquency is when your tenants pay their rent late or stop paying altogether. This shouldn’t be a huge problem if your property is in a good area of town and you’re screening your tenants properly, but it’s an expense to keep in mind.
- Mortgage: Your mortgage or the Principal, Interest, Taxes, and Insurance payment (PITI) of the year will take the bulk of your expenses.
In general, you should aim for a net cash flow between 10% and 12%.
#2 Appreciation
Often regarded as the cornerstone of real estate wealth, appreciation is perhaps the most widely recognized avenue for profitability when it comes to rental properties. Moreover, with its proven track record of delivering consistent returns over time, appreciation is one of the major catalysts behind the remarkable wealth generated through real estate investments.
Appreciation is when your property value increases due to various factors, including:
Improving a property
When you rehab your property, it creates an appreciation because your rehabilitation will increase the property’s value. For example, you bought a rental property for $100,000 and rehabilitated it for $25,000. After your improvements, the property’s value is now at $150,000. That means you have an extra $25,000 in free money.
This kind of appreciation is called forced appreciation.
Location
Where you bought your property will be a primary driver of appreciation. The latest Freddie Mac House Price Index (FMHPI) report shows that the average house prices in the United States increased by over 37% in the past five years.
Just remember that some real estate markets have a better appreciation than others. For example, due to their high percentage of renters, Atlanta has seen home prices increase by about 50% in the past five years. Meanwhile, home prices in areas where the cost of living is high, like Trenton, New Jersey, have only seen an increase of 29% during the same period.
That’s why it’s essential to be smart when choosing locations for your rental property and understand the local market trends to capitalize on the appreciation.
#3 Amortization
Another lucrative avenue that often flies under the radar is amortization. It is the process of paying off your loan through regular installment payments, including both principal and interest. But instead of using your personal funds, you use the income you get from rent.
You’re not using your own money to do this—your tenant’s rent is doing the job!
Imagine this: You’ve got a 30-year fixed mortgage. As time goes by, you’ll notice that you’re paying off more of the principal each year than the previous year. That’s how equity starts to build up. Equity is the difference between your property’s value and the amount you still owe on the loan. And it’s growing yearly without you paying more money from your pocket.
So, the more your tenant pays rent, the faster your mortgage gets paid off, and the more equity you’re building up. It’s like a win-win situation where you’re using someone else’s money to grow your wealth.
#4 Hedging Against Inflation With Your Property
Having a real estate property is one of the best ways to hedge against inflation. According to the Federal Reserve, the annual inflation rate in the U.S. since 2016 is about 2% per year. And when it comes to rental properties, the more inflation there is, the more profitable it becomes because rent increases.
Let’s look at an example to make things clearer: Say you have a rental property with a fixed-rate mortgage, and your monthly mortgage payment is $800. Let’s assume that inflation caused the rent prices to increase by 5%. So, your tenant’s rent also goes up by 5%, from $1000 to $1,050.
But, because you have a fixed-rate mortgage, the payment remains at $800. So that means you’re now pocketing an extra $250 each month, just because of inflation.
#5 Capitalizing on Tax Benefits
Taking advantage of tax benefits can help reduce your taxable rental income and increase your overall profitability. You can do this by familiarizing yourself with real estate tax laws and working with an expert accountant so you can identify deductions and benefits available to rental property owners.
Most real estate investors make a lot of money and pay very little in taxes because they take advantage of the tax benefits the IRS gives to real estate investors. Some of the real estate tax write-offs include but are not limited to:
- Operating expenses and repairs
- Mortgage interest
- Insurance and Property taxes
- Legal and professional fees
- Travel expenses for remote real estate investors
Utilizing these tax advantages can potentially lower your tax liability, freeing up more funds for investment or improving your property.
Earn More by Knowing More
There are many ways real estate investors can make money off their properties. The only hindrance to most is not knowing how to capitalize on these opportunities. So, knowing that your rental property can make money and earn you a profit in five different ways can be exciting.
So, the best thing you can do right now as an investor is to understand these five profit centers and apply your new knowledge to analyze how you can profit from your rental properties.
Our team has been operating a property management company in Metro Detroit for over two decades. Contact us today, and we’ll help you bring more money into your pocket with your rental properties.