¶ Welcome and Show Introduction
Welcome to Passive Real Estate Investing, the show where busy people like you learn how to build substantial passive income while creating wealth for the long term. And now, here's your host, Marco Santorelli. Hello, my friends. Welcome back to Passive Real Estate Investing, where we dive into the world of real estate investing, among other related topics to help you with your real estate investing journey. Today we're doing something a little different.
We're going to take a trip down memory lane and showcase an important episode from the past on what we call our Throwback Thursday episode. Now, whether you've been with us since the beginning, which goes back to 2015, or you're tuning in for the first time, This episode is a must listen. We are revisiting one of our more popular episodes from the past and believe me, what we discussed back then, whether it's six months ago or six years ago, is just as relevant today.
So sit back, relax and let's rewind the clock for this great episode. Enjoy.
¶ Real Estate Has Multiple Returns
You know, you'll often hear people say that they don't like real estate because if you look at the long-term, returns of the stock market seem to be a better return overall. Well, of course... When they say stuff like this, they are leaving out a few important things, a few key things, because they're looking at real estate as being...
very one-sided or one-dimensional asset. And that's not the case as it is with most other investments like the stock market. First, when people say the stock market What they really mean is something like the S&P 500 or the Dow Jones Industrial Average. These are not the stock market. Rather, they are indices filled with some of the leading companies in the U.S.
You'll often hear that the stock market makes returns somewhere from 7% to 8% or 9%, 10% annually. And this is really based on the index returns rather than the market itself. Second, while a 7% to 10% return is good annually for the average person, it is not a good return or even a great return for the professional investor.
And when you stack up the returns from real estate against the stock market, they often only factor in that one profit center in real estate, and that is appreciation or capital appreciation, or you might just call it capital gains. The reality is that there are four ways you can make money with real estate that, when you add them all up together, make for a considerably higher return.
than the stock market. And these profit centers are the reason that real estate is one of my favorite investment vehicles. And I'm going to throw a bonus profit center in there today. We'll call it the fifth profit center. which I'll talk about here in a minute. But at the end of the day, you have to understand that real estate is multifaceted or multidimensional. It is not just one rate of return you have to look at it holistically and look at each of those returns
together to really understand the true power of real estate and what it can deliver for you as an investment. Now, here's a quick word of clarification. As I talk about this, realize that I'm talking about investment real estate, not property that you buy specifically to run a business or more specifically. your personal residence. And as I've talked about in previous episodes, your home is not an asset. It may be to the bank if you have a mortgage on it, but it's technically not a asset.
doesn't generate cash flow or income it puts money in the pockets of your county for property taxes and money in the pockets of your mortgage lender if you have a mortgage loan on it. It's not putting money in your pocket, at least not unless you sell it years down the road and realize again. in terms of capital gains, but essentially it's an expense. You're putting money into it every year.
¶ Profit Center One: Cash Flow
From that perspective, investment real estate is investment property that puts money in your pocket. Now, the first profit center is essentially the cash flow or the cash flow on operations of your business. if you're holding real estate as an investment you will have tenants and each month these tenants pay rent now let's say you own a home and you are receiving a thousand dollars a month in rent
Great. That's $12,000 a year in gross income. When you subtract your expenses, which includes things like property taxes, insurance, your property management, if you have a property manager, and you're budgeting for vacancies and you're budgeting for a turnover. ultimately your tenants will move out, then what you're left over with is your net operating income.
This is what's left over to pay your mortgage payment, also known as debt service. And then anything left over after that is your cash flow, often referred to as positive cash flow, but it's cash flow nonetheless. And so this is the cool thing about real estate is that immediately month one, you can be.
receiving income or cash flow from your property which is a form of income it is a form of profit and over the course of the year you will have cash flow over the course of that year and over the course of years you'll have cash flow over the course of time that adds up. But this is just one pillar or one asset profit center. And you have to understand that a lot of people buy real estate specifically for the cash flow of that real estate.
But this is great if you are in a position where you have time on your side and you can let the equity grow in the property and you're just in it for the cash flow. But some investors are focused on growth and they want the appreciation. And so cashflow becomes less important to them. They don't need as much of it as they would if they were focused on cashflow. So, you know, there's two types of investors, those that are in a position where
They don't need the cash flow. They're focused on capital growth and growing their portfolio. And there's those investors that have their goals set on maximizing their cash flow. They're not so concerned about the capital growth of their property or properties. they're going to focus on maximizing their initial cash flow. Now, I'm going to compare these for you in a minute here, and you can see which ones provide you the greatest returns over time. And in often, some cases,
¶ Profit Center Two: Amortization
give you the greatest returns immediately but that's not the end of the story here remember there's four major profit centers so the next one i want to talk about is the amortization of the loan i'm going to make the assumption that you have mortgage financing on your property and that that is the way you want to invest as most investors do and something that certainly i'm a big fan of and we are a fan of here at norada real estate is because you can leverage your
investment capital and make it go further and build a larger portfolio by using OPM, other people's money. So amortization is simply the concept of paying down your debt. Each month when you make a mortgage payment or a debt payment, however you want to call it, now remember, it's your tenant that's making that debt payment, not you.
But every month when you make that mortgage payment out of your net operating income, a portion of that goes towards paying down the principal on the loan that you have on that property. So when you're talking about a 30-year fixed rate... fully amortized loan which is the most common type of financing that you get on rental property
you will be making a mortgage payment that pays down that principal over 360 payments. Of course, if you pay it off sooner or you accelerate those payments, you'll have fewer than 360 payments. But you'll ultimately pay off that loan over time until it reaches zero. And at that point, whatever you had as a principal.
amount in that loan becomes equity so your equity grows as the loan shrinks and that's all that amortization is it's the pay down of the principal on that mortgage loan which increases your equity at the same time. So if you look at that or you step back and think about it, it's really a form of return because the equity is growing in the property as your tenant pays down that mortgage. Put another way, think of it this way. Your tenant is paying rent and that rent covers the debt payments.
principal pay down included in that debt payment is actually profit to you. And we're going to take a look at a real example here in a moment where I break down a property and show you what the rates of return are on each of these profit centers. There's another similar form of profit that comes from the appreciation. Sometimes people think of appreciation as frosting on the cake. Other investors, those that are growth oriented like.