Are you thinking about renting your home or investing in rental properties locally? If so, there are a wide variety of ways that rentals make money.
In this article we will share you several ways that rental properties make money so that you know how to get more ROI from your property and portfolio.
Appreciation
Probably the most popular form of profit when people think of rental properties, appreciation has been a consistent performer over time and one of the biggest players in what makes people so wealthy from real estate.
Appreciation is when the value of a property increases due to various factors.
The three main causes of appreciation are:
- Improving a property
- The location
Improving a property
Rehabbing a property will create appreciation because that rehab has now increased the property’s value. In most cases, the increase in the value of the property will be more than what the investor had to pay to complete the rehab.
For example, let’s say you buy a $100,000 property and put $30,000 into a rehab. With all of the improvements, the property is worth $150,000. You only put in $130,000 ($100,000 plus the $30,000 rehab), but now the property is worth $150,000. There’s an extra $20,000 in free money thanks to the appreciation generated by the rehab.
This kind of appreciation is called forced appreciation.
Location
The location you bought the property in will also be a primary driver of appreciation. If the demand for housing in the area—the broader market or the specific neighborhood—rises, so will property values. Demand may rise due to general market growth, or it may be because you bought in an area that got intentionally gentrified, which could force quicker and more dramatic appreciation.
In addition to improvements and demand increasing the value of a property, an investor may likely also experience appreciation in the market value of rental income. Rents inevitably increase over time due to several factors, but what causes appreciation to the value of a property will usually trigger appreciation in rental values as well. When the rents increase, your cash flow will increase proportionately.
While appreciation is one of the highest profit centers of a rental property, it’s also speculative. It’s never a guarantee that the reason you believe a property will appreciate will pan out as you assume it will. You should always consider contingency plans on how you expect a property to profit should the appreciation strategy fold.
The other consideration to remember is that rental properties are long-term investments, and often true appreciation potential is experienced over the long-term rather than the short-term.
Building Equity Through Mortgage Payoff
One of the coolest things about owning a rental property is that your tenants’ rent check is most likely covering your mortgage payment! Hopefully, it’s covering more than that, but if it’s at least covering your mortgage payment, it means that you aren’t the one paying down your mortgage—they are.
Here’s an example: You buy a $100,000 rental property with 20% down. That means you paid $20,000 upfront and the remaining $80,000 is the balance on the loan, in addition to interest payments.
Over 30 years, the mortgage balance is paid down every month through the income you receive from your tenants. At the end of those 30 years, $80,000 has been paid off and you now own the property free and clear. The $80,000 isn’t immediately liquid because it’s in the form of equity, but it’s your money, and you can either keep it as equity or pull it out of the property and use it however you wish.
The bottom line is that you turned $20,000 into $80,000, plus any appreciation that’s most likely occurred over 30 years.
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