Making good choices, with the help of your broker and taking some risk can have you on your way to creating wealth. I have had the pleasure of watching several clients meet or exceed their goals, but it isn’t always a monthly trip to the bank to deposit rent checks.
Pete is a great client who purchased his first investment property through me about ten years ago. I actually have his office building currently available for lease. Unfortunately, the office leasing market is soft right now so it is still vacant after two months.
It is uncomfortable having a property vacant for prolonged periods because it is money lost. Pete asked me what he should do and wondered if maybe it is time to sell because the sales market for office buildings is great.
I told him to have patience and took him on a walk through time to remind him how his investment has grown over the past ten years. In this series of articles I will present Pete’s case study to you.
First, let’s look at the five compelling ways a real estate investment like Pete’s can make you wealthy:
Positive Cash Flow
You have net operating income and cash flow. Two keys to a successful real estate investment: don’t purchase a property with negative cash flow and make your profit going into a property.
The net operating income or NOI is rental income minus expenses to operate the property. Cash flow takes into consideration any loans, reserves and leasing commissions.
For example, your rental income is $5,000 a month, your expenses like maintenance, taxes and insurance is $1,500 a month. The remaining $3,500 is your NOI. Now subtract your loan payment of $2,000 per month and reserves of $500 per month for future capital improvements and that leaves you with a positive, before tax, monthly cash flow of $1,000.
This may not make you a millionaire, but you are headed in the right direction.
Securing a loan can be a prudent decision for purchasing investment real estate. Under the right terms, financing can improve the leverage of your down-payment. As you make your loan payments the loan is amortized, which is a fancy way of saying being paid off.
For example, you use $250,000 of your own money for a down-payment and secure a loan for $750,000 at 4.5% interest amortized for 25 years to purchase a $1 million commercial building. Your down-payment money potentially is earning a higher rate-of-return in the purchase because it was leveraged to purchase a $1 million property.
Each month your loan payment includes an interest payment and a principal payment. Each payment will reduce your $750,000 loan thereby increasing your equity.
I am going to stop there as I have given you a lot of lingo and investment basics. In my next article we will discuss the third compelling way real estate can make you wealthy.
Burt M. Polson, CCIM, is a local real estate broker specializing in commercial, luxury estates and wineries. Reach him at 707-254-8000, [email protected]. Sign up for his email newsletter at BurtPolson.com