There are five basic real estate concepts every investor must understand and I’ve outlined each of them in the video below and text below.
When an asset increases in value it is said to have “appreciated”. The opposite of appreciation is depreciation, which is the decrease in an assets value. I concept of appreciation is important to the “buy and hold” real estate investors because (typically) the longer and asset is held the higher it value. The increase in real estate values has usually kept pace or grown faster than the US rate of inflation, hence why it’s known as one of the best hedges against inflation. You can estimate your property’s future value by using a “compounding calculator” and choosing a rate of inflation. I like to use the rate of 2.5% which is relatively conservative.
Amortization (Debt Pay Down):
Amortization is the systematic decrease in your investment property’s debt. When you make your mortgage payment each month a portion of those payments decrease the principal balance of your mortgage and a portion will go to the bank in the form of interest payments for the use of their money. In the first 5-10 years of a 30 year mortgage the majority of your mortgage payments will go toward interest. You start to pay off more of your principal balance toward the middle and end of your amortization period. You can calculate your principal balance at a future date by using a mortgage calculator with an “amortization schedule” attached.
Your equity “spread” can be calculated simply by taking the value of the property at any given point and subtracting the debt on the property at that same point. When you first buy an investment property your equity spread is equal to your down payment, assuming you purchased the property at market value. To find your equity position at a future date in time, calculate your future value and your future principal debt on the loan and subtract these two number.
Cash flow is the money left over after you’ve collected all your rental income and paid all your rental expenses. If you’re renting two 3 bedroom condos and collecting $2000 from each unit, you have a monthly “gross income” of $4000 from your rental portfolio. If your mortgage, taxes, insurance, water and repair expenses total $3000 per month you have a surplus or “cash flow” of $1000 monthly or $12,000 annually.
ROI (Return on Investment):
ROI is a measure of your investment performance. For example, if I have a stock investment and it provides me with and ROI of 6% and a rental property that give me an ROI of 10%, than my rental property is providing me with a better return on the money I invested. The higher your ROI the better.
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