How income producing real estate makes money.

Real estate is everywhere and limited at the same time. As you have heard before, location, location, location. Plus a whole industry awaits to serve your needs - agents, management companies, bankers, appraisers, title companies and of course syndicators. The astute real estate investor tries to find the highest and best use of the property. The goal is to increase the net rental income and thus the overall value of the property.

Income producing property can make money in several ways:

The following is a general discussion of the ways income properties can return a profit for the real a estate syndicate and it's investors.

Income or cash flow: A carefully selected and properly structured real estate deal can produce rental income. That income increases as the value of real estate in general increases and owners of competing properties raise rent rates, as rents go up you can increase your rent rates. Rents trend to go up at about the rate of inflation. Rents can go up faster then the inflation rate if the demand for rentals is higher then the supply of vacant space. The value of income property has a direct relationship to the properties net income. Anything that you do to increase net rental income increases the properties value.

Tax Savings: The IRS tax rules in the US, allows you to take depreciation on the structures and improvements on a property. Depreciation allows you to delay the taxes on a part of the current income and pay the taxes later at long tern capital gains rates when the property is sold. Other tax rules allow you to postpone the taxes on the long-term gains on property. You can deduct the interest on the mortgage, and deduct the operating expense against the income generated from the property. If this produces a taxable loss, you can possibly use that loss to reduce your earned income. Taxes is a complicated subject that requires some study. Areas that you should investigate are are, Real Estate deductions, deprecation, component depreciation, alternate minimum taxes, passive loss limitations, and LLC and LLP tax pass through rules. Booklets are available from the IRS and the government printing office as well at irs.gov.

Leverage: Using your investors money for the down payment you can borrow to finance the acquisition of a property. By borrowing, you can control a larger property with a larger income stream than would be available from a smaller property that you could afford to pay cash for. Using borrowed funds is only profitable if the interest rate charged on the loan is less then the net profit percent generated from the property's income. Example: An income property that produces a 14% net return on the total purchase price, that has a loan equal to 70% of the purchase price at a 7% interest rate would have a leveraged return of 7% on the amount of the loan. You would then have a larger percentage return on the actual cash down payment. The 14% return might be 21% to 28% or more. Careful analysis is warranted. (14 -7 = 7 X 2.3 = 16 + 14 = 30)

Equity Build up: Using the rent money to pay down your investors mortgage. Each time a payment on the mortgage is made, the principal portion of that payment increases the investors equity in the property and thus increases the return on the investment. Equity build up from reduction of the mortgage balance along with increasing value of the property from inflation, combined with leverage is the real magic of real estate investing.

Flexibility: There are many ways to buy, finance, control, and dispose of real estate. Such as mortgages by the VA, FHA, owner carry notes, purchase money mortgages or deeds of trust, wrap around mortgage, blanket mortgage, and rent to own, to name a few. Most of your deals will be 30% down conventional loans. Keep in mind that all aspects of a real estate transaction are negotiable.

Appreciation: A properly maintained property will increase in value over time. The more desirable the area your property is located in, the faster the appreciation. Income properties increase in value in direct relationship to the net cash flow from the property. Each $1 in net cash flow is worth about $10 in value.

Inflation Protection: Real estate has historically increased in value at or higher than the inflation rate. The rental income can be increased as prices, in general increase, thus protecting the properties cash flow from inflation.

Highest and best use: Real estate lends itself to repositioning to a higher perceived vale. The value of real estate is in the eye of the user. What are they willing to pay for your property or for the use of it. If you remodel a property it has a higher value then an out of date property. If you can collect more rent from the renters, you have raised the over all value of the property. Anything you do to increase net income increases value.

 Additional income sources:

There are many ways to increase the net rental income and thus the value of your syndicates property.

Some of these are additional sources of income are, covered parking, adding garages, rehabbing the property to a higher class of property, adding a laundry facility, adding mini storage units in the parking area, renting excess land for cell tower or a radio tower, using the side of the building for a sign, renting out any common area buildings for events, etc. Think, and look at what others are doing, steal every good idea that you can.

 One flexible landlord's deal

An office building owner had a 2,000 square foot office space for rent at $2,200 a month. His real estate agent called him one day with a story of a possible tenet that was having difficulties locating office space. The agent knew the building owner was flexible in working a deal. It seams the client needed 2,000 square foot plus of space, but the client being a government contractor could only rent on a one year basis with no assurance of a renewal. The deal was further complicated because the client wanted the office space furnished, they had the same time line problem with renting office furniture.

The real estate agent and the agency company he worked for did not want to work with the government contractor client because agencies get paid a commission on the total value of the lease. They where not interested in one year, short term deals. Most building owners are not interested in renting to a client on a short term bases because mortgage bankers want three year or longer leases before they will approve loans or loan renewals. This building owner had been sending potential clients leads to the real estate agent for years. Thus the quid pro quo call to our office building owner.

The potential renter liked the space and the building owner agreed to paint, add new carpet and furnish the space for the client at a rent of $3,000 per month. The building owner spent $18,000 doing the required work and adding the furnishings. The increase in rent was $800 a month more then he was asking for the space unfurnished, giving the landlord a twenty three month payback on the expended cash. As the space had been empty for two years the owner figured he would be $18,000 ahead the first year, versus having the space remain empty even if the client did not renew. If the client renewed for another year the landlord would be way ahead as we was getting class A rent on class B space. Figuring that with the difficulty of locating space on the terms the client wanted, the chances where good they would renew.

The real estate agent made the introductions and then bowed out, forgoing any commissions as his boss was not interested in short term lease deals, and the real estate agent was paying the building owner back for sending him business. The client is now in year three of the rental and the building owner is happy.

 Reducing expenses increases value

Many years ago I was manging a 40 unit apartment building, the apartments had covered parking, a laundry room and a nice big pool. We rented to all comers with the result that we had young families, elderly couples and a few single people. We also had high maintenance cost associated with laundry room repairs, pool servicing, noise, appliance repairs especially garbage disposal problems, trash service problems and non-running car problems and so on. The older people complained about kids and noise, the young people liked pool parties, and we had the occasional eviction for non payment of rent. The result was a thirty percent tenet turn over resulting in a 15% vacancy factor.

With the approval of the owner I changed the name of the apartments to “Elder-Oaks” a play on the name of trees. I added “Elder Apartment Living” to the sign. Every time some one moved out we changed the paint colors to beige and antique white, added new appliances and a monitored security service. We advertised the units as retirement apartments and rented to people over fifty years old. In took two years to convert the tenet base but most of the problems went away, the operating cost went down and the tenet turn over stopped.