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Back to the Basics: How to Make Money in Real Estate

by Julie Broad

"In the moment of decision, the best thing you can do is the right thing, the next best thing is the wrong thing, and the worst thing you can do is nothing." - Theodore Roosevelt

I was in Toronto a couple of weeks ago and many of my colleagues in the real estate space were talking about lay offs...those that had happened and those they expected to come. But, despite the gloom, I'm even more convinced that now is the time to start shopping for property. Smart money is entering the real estate market right now. If you're sitting on the sidelines afraid, or worse, if you're running in fear, then you're missing out on some great opportunities.

With values dropping, someone who is out there looking just mind find a deal! Even if property values drop for another year you can can still make money in real estate. Here's why...

There are three ways to make money in real estate:

* appreciation,
* cash flow, and
* other people's money paying down your mortgage.

Appreciation is the way that captures an audience. Who doesn't want to hear about the person that made $200,000 on their house in 3 years? And who doesn't want to imagine how wonderful it would be to have bought that $200,000 house 3 years ago to be selling it for $400,000 today?

Well those big story days of rapid home value appreciation are behind us now.

And we're ok with it because we never set out to make money through big property value appreciation. We've always focused on a more long term strategy...making money by other people (our renters) paying down our mortgages. We focus on the fundamentals of real estate investing - buying a good property, in an area that attracts a good base of tenants, and renting it out for more money than it costs us to hold that property.

Let's look at a basic example of just how powerful the fundamentals can be. Pretend you found a desirable property for $100,000 two years ago, and you bought it for 25% down ($25,000). Today, here's how your investment looks:

1) Depreciation: Bad news, your property went down in value by 5%. It's now worth $95,000.

2) Cash flow: Rent each month is $1,000. Your mortgage, insurance, taxes and miscellaneous expenses are $800/month. Income minus expenses = $200/month. 24 months x $200 = $4,800 in income so far.

3) Other people's money paying down your mortgage: Assuming you have a mortgage at a 5% fixed rate and 25 year amortization, at the end of the two years you will owe $71,805 on your $75,000 mortgage. You have now built an additional $3,195 equity into the property ($75,000 - $71,805 = $3,195) using the rent money you collected to pay down the mortgage.

Your property may be worth less than you bought it for, but you've still made $7,995 from it in two years (from the positive monthly cash flow and the principal your renters have paid down). Given that you only realize the gains or losses from price changes when you sell or refinance the property, (so the decreased value doesn't really factor into your returns at this point) you've made a 32% return ($7,995 divided by $25,000 invested) on your money after 2 years. And if you hold onto it, and ride the market cycle back up, when you do go to sell you'll likely enjoy a nice lift in value to add to the other two ways you've made money on it.

So, read the media messages about the real estate market crashing if you must. But read them and smile, because you know that you can make money in real estate by going back to the basics and focusing on the fundamentals. And remember, the market won't always be like this. (If you don't believe me, just ask Bruce Flatt...).

"In the middle of difficulty lies opportunity". - Albert Einstein

Published November 17, 2008