The Bonus Return Most Investors Don't Realize They Make

When it comes to investing in real estate, there are different ways that passive investors can make returns. It is essential to understand these methods to make informed investment decisions. In this article, we'll discuss the three major ways investors make returns, and we'll share a secret fourth type of return that few investors know about.

Quick Notes:

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Cash Return from Rents

This is the most common type of return that investors think of when it comes to investing in rentals. Cash return is the free cash left after covering all expenses, including operating expenses, capital expenses, and loan payments. Although it is an essential return, it's important to note that it generally represents the lowest amount of return in a deal. A class B property may offer around 3-6% cash return early on, which can grow closer to 10% after a few years. Still a great return, but typically not as much as the next method.

Forced and Market Appreciation

Market appreciation comes from imbalances in supply and demand and natural growth of a geographical area. To capitalize on market appreciation, we look for things like income growth and job growth (and thereby population growth) as they compare to new construction pipelines.

If we see an imbalance in population growth when compared to new construction, we know this market is prime to experience market appreciation.

On the other hand, forced appreciation is appreciation that operators have control over by increasing the net income of a property. If the income increases while expenses decrease, the asset becomes more valuable, and investors can realize significantly larger returns at sale or refinance.

Tax Benefits

**consult your own tax professional when it comes to your specific tax situation. This is just a very high level discussion of what we’ve generally seen in our experience**

Depreciation is a tax benefit that allows investors to account for wear and tear over a 27.5 year period, and sometimes even accelerate that into a smaller time frame. This depreciation allows investors to get income from a property but actually show a loss in the eyes of the IRS to shelter that income from taxes.

Principal Paydown

The secret fourth way of making returns in real estate investing is through principal paydown. This happens when tenants pay the mortgage every month, and the outstanding loan balance reduces.

Historically, operators have cited seeing an additional 2-4% annual return come from principal paydown. Although this return may not sound like much, it's not factored into deal packages. If principal reduction is involved in the investment then it becomes an additional bonus for investors.