Real Estate Investing: The 3 WAYS to make money owning Real Estate

What's up you guys? It's Graham here. So I thought this would be a helpful video to discuss the three ways you make money when owning and investing in real estate, and exactly how I calculate and assess my returns based off real-world examples.

Because very rarely, anytime you invest in real estate, is it as simple as saying, "I make ten thousand dollars per year off a hundred thousand dollar home," and that is a ten percent return on my money. It's never like that, and the reality is it's much more intricate and expansive than just that.

So let's discuss exactly what this is, how you can calculate these returns, and exactly what I do. And, as always, if you enjoy content like this, make sure to hit the like button. It does really help out a lot. If you're watching this and you're not already subscribed, we gotta have a serious sit-down. I guess I'm already sitting down, so we gotta have a serious sit-down talk here. Why you're not already subscribed? Just hit the subscribe button, super easy to do, or the like button.

Let's get into it. So let's start here: the three ways to make money while owning and investing in real estate. The first one is net cash flow. Now, this one is the most obvious, but it can often be the most confusing because anytime you calculate cash flow, you first get what's called your gross rent. This is the total amount of rent you receive on the property.

So, if you rent out your house for, let's say, $2,000 per month, this is what's called your gross cash flow. It's the total amount of rent you receive before any of your expenses. Unfortunately, anytime you own real estate, you do have recurring expenses, whether or not the property is rented. This includes property taxes, insurance, just repairs that happen over time. There are a multitude of things that eat into the cash flow every single month.

Then, of course, it's inevitable that, at some points, you will have a vacancy where the property's just not rented, but it's still costing you money. All of this stuff is pretty much inevitable. So the first step when you calculate your cash flow is to deduct all the expenses from the property against the total amount of rent you receive.

So even though you might think you're golden, you're getting $2,000 per month, maybe after all of your expenses, you're really only getting $1,200 a month. So anytime you see real estate returns calculated like this, and you talk to all of your expenses, this is called the net operating income. It's basically the total amount you receive, your gross rent minus the expenses you have on that property, and then you get your net income.

Now, usually, when you're looking at investment properties online, all of these numbers and calculations are done for you. But it's really important that you learn to do this yourself and exactly what to look for, because oftentimes, anytime you see them calculated for you online, they're usually not a hundred percent accurate. It's very common that, oftentimes, the expected ROI on a property is wildly optimistic.

Oftentimes, they just assume you're getting top market rent, low expenses, best-case scenario, and they're basing their numbers off of that. And as we all know, that rarely ever actually happens in the real world. So you'll need to have an idea of what property tax rates are like in your area, how much it's going to cost to pay for insurance on that property, what you can realistically get for rent—which is a big one. A lot of people are very optimistic on this—and just how much turnover you will expect to have, given the area.

Now, one thing that's almost rarely ever calculated for you or projected in these numbers is your mortgage payment. The reason why is that your mortgage payment can vary wildly from person to person depending on their credit, how much money they put down, any interest rate of the loan. But I would say, in probably almost every single situation, your mortgage payment will be an expense against the total rental income.

Unless, of course, you're a boss and you just decided to pay cash for it. But let's be real, very few people are gonna be paying cash for real estate, and they will have a mortgage. So in our example, where I suggested the home rent for $2,000 per month, and then after your expenses of property taxes, repairs, vacancy, and everything else that goes along with it, you're left with about $1,200.

But then, let's say you have a mortgage on top of that that costs you another nine hundred dollars per month. Well, this means you're really only left with three hundred dollars per month in net profit from the two thousand dollars per month that you were receiving. It's quite the difference.

This is why I absolutely can't stand the people that say landlords are parasites that just profit off them. Because they assume that all the two thousand dollars that the landlord gets is pure profit. Couldn't be further from the truth. In reality, it costs a lot of money to maintain and just own the property in the first place.

Many landlords will not make a significant amount of money just from owning one or two properties, and many more landlords will often just break even on their investment from the rent they receive. But instead, they'll rely on the economies of scale and owning a lot of properties to actually make a significant amount of money. Even if they only make three hundred dollars a month in profit from all the work that they put in, all the investment that they put in, all the time that they put in, when you consider that some of these landlords are gonna own ten, twenty, or thirty properties, all of a sudden, at that point, it really starts to add up to something significant.

But calculating how much money you can get from rent after all of your expenses is easily the most important part anytime you're investing in real estate. So with that said, anytime I look at a property, the first thing I want to know is how much I can realistically get for rent. Often, where I will look here in the United States, at least, is Craigslist, and I'll see what comparable units are actually being rented for.

Other times, I can calculate how much you'll get from rent just based off of the last ten years of experience in doing this and knowing the location and the condition of the unit. I have a pretty good idea of what I can get in rent. From there, I'll deduct the amount of money I'll pay in property tax, which here in LA is about one point two five percent of whatever the purchase price is.

Then I'll deduct money that I would be spending on insurance. Here in LA, on average, it's probably about one dollar per square foot per year. Then I'll deduct a reasonable vacancy rate for the area which here in LA could be anywhere from three to maybe sometimes six or seven percent depending on the area. I'll also deduct some anticipated repairs just based off the age of the building.

I then determine how much money I will need to put down on the deal, how much the mortgage is going to cost me, and then calculate if there's any money left over to actually make a realistic profit. Now, I would probably estimate that forty-nine times out of fifty, there's zero money in the deal. There's no money to be made. I cannot make a profit based off the purchase price or the rents, and I simply just move on to the next one.

And don't worry if you're at all confused; I will walk you through an actual random deal I'll look at on the Internet towards the end of the video. So just stick around, and at the very end, I'll do that.

Now, the second way to make money in real estate is through equity. This means that the property value is going up based on something you're directly doing to it. Now, when it comes to making money and equity in real estate, there are two ways to do this. The first and most common way to build equity in a property is through paying down your loan every month.

In most situations, your loan is broken up into two categories: the first one is principal, the second one is interest. This means that every month you're paying a portion of the principal and also paying interest on the total amount that you owe. Even if you buy a $500,000 property with a $400,000 loan that's paid off over thirty years, this means that the average over thirty years, you're paying down your loan by about thirteen thousand three hundred and thirty-three dollars per year.

That increases the amount you actually own of that property, and that also means that your net worth is going up. So this means that hypothetically, if you own a property that does not give you an extra dollar in profit but it just simply breaks even every year, your worst-case scenario is that after thirty years, you own that property one hundred percent outright.

Now, the second way to make equity owning real estate, and also my favorite way, is by adding value to the property. This often means remodeling, adding square footage, or adding something else to the property that increases its value. The equity that you get is the difference between how much money you spent remodeling or adding value to the property and the total value after you've done those renovations.

So, let's just say you spent fifteen thousand dollars renovating a kitchen and now your property's worth thirty thousand dollars more. This means that you essentially just made fifteen thousand dollars in equity. Or let's just say you spent a hundred thousand dollars adding a thousand square feet to your home, but now the home is worth two hundred thousand dollars more because it's a thousand square feet bigger. Well, this means you just made a hundred thousand dollars in equity.

So, I'm sure you get the idea with all of this, but doing this is also really predictable. You can see what other similar homes are selling for with similar renovations and then project what you can get for your own based off those other sales.

Now, some people out there are going to troll a little bit, and they're gonna say something like, "That equity is not money; you can't go after it; you can't spend their equity thing; they have to give money, did that," and so on. But to me, that's the entire upside of all of this.

Because the equity is somewhat imaginary money. This means that unless you actually sell the property and take a profit, none of that equity is ever taxed. This means that you're able to refinance your loan to pull out the equity completely tax-free, and then all of a sudden, that's the money that you could then go and spend on whatever you want or use that money to invest in another property.

That's exactly what I did with my last deal when I bought the duplex. I remodeled it and had the option to pull out up to 180 thousand dollars in extra equity from that deal that I could then go and reinvest anywhere else. Or I could buy a Lambo.

But just so this doesn't turn into a thirty-minute video, I have several other videos that I've made exactly about the refinancing process, pulling money out, reinvesting, so the links will all be in the description if you guys want to check that out just to save on time on this video.

But anyway, I see equity like this: the imaginary equity money is a great thing because it's not taxed, and this is the best part of all of it.

Now, the third way to make money in real estate is through appreciation, and this means that just generally over time, the property value increases. Now, this one is highly dependent on the property's location. Many properties will simply just go up at the rate of inflation just because the cost to build a home similar to that just naturally tends to rise over time.

But other areas, like big cities such as New York, San Francisco, Los Angeles, or anything similar to that, have a density problem, which means that there's only so much land you can build on. And because of that, and because of additional supply, housing prices go up significantly above inflation.

Now, if you're in an area where property values simply go up with inflation, there's nothing wrong with that because technically your money really isn't losing any value, and it's simply just a preservation of wealth. But if the property values go up above inflation, well, this just means you're making a little extra money.

For instance, there's an area in Los Angeles called Baldwin Hills, and I did some research on Baldwin Hills because I really like the area, and that's the place I really want to buy. Well, I found out that many parts of Baldwin Hills with a good view have gone up in value about five percent per year above inflation since 1950.

This means that you can simply buy the property, do nothing to it, keep it empty, and you'll still make five percent per year after inflation. But overall, I would assume it's pretty realistic just for the home to go up in value about inflation, which works out to be somewhere between two and two and a half percent per year.

Or if you're in a really concentrated city like Los Angeles, San Francisco, New York, Vancouver, or places like this, I'm gonna guess you'll probably see returns more like three to six percent annually. Or if you're in really up-and-coming trendy spots, maybe like Portland, Oregon, or Dallas, Texas, or places like this, you might see returns more like six to ten percent per year.

But it's not gonna last forever. You could, in the short term, see some pretty crazy appreciation rates. But all of this is extremely highly speculative, and there are so many variables that go into play on this, and it could be extremely volatile.

So anytime you're basing your returns off appreciation, I would definitely do that with a grain of salt and not expect anything.

So, when it comes to making money in real estate, like I said, three ways: net cash flow, equity through both paying down the loan and forcing renovations and adding value to the property, and third is appreciation.

Once you calculate all of these, you can really come up with the actual return you're going to get, because I promise you it's a lot more than just net cash flow. It's also gonna be how much you're paying down the loan every month, the extra equity you can do to the property by renovating it or adding some sort of value, and also is the property going to be going up in value over time.

So let's go to the computer really quick and let's come up with a random real example of how I calculate the value of a property.

So, let's consider this random example here. This is a random house that just came on the market. You can see days on market: 1. Let's figure out, first of all, how much this house is going to actually cost every single month and also how much you can get in rent.

Let's just assume we get this house for eight hundred and fifty thousand dollars, and you're going to have to pay twenty percent down. So, the first thing I like to do is go to my favorite site, Google, and we do mortgage calculator.

Then what I like to do is use this site: you can tell they've already clicked on it—mortgagecalculator.com. So the home value, we're going to put eight hundred and fifty thousand dollars, we're going to put twenty percent down; that leaves us with a loan of six hundred and eighty thousand dollars. Right now rates are about four and a half percent, thirty years.

I always start the date to January so we can get a full idea of what it's like per year. I'm gonna leave this stuff blank for right now, go to amortization table, I will show annual and monetization, and we could click calculate.

So right now we can tell that this house is going to cost us thirty-four hundred and forty-five dollars per month in a monthly mortgage payment. So what I'd like to do is we go to notes, and we type in thirty-four forty-five per month in mortgage.

The next thing we have to do is calculate how much property taxes are going to be. Here in Los Angeles, it's about one point two five percent of the purchase price. So what I like to do, I'll bring this down a little bit. I basically just go up to the top: eight hundred and fifty thousand times point zero one two five, and that is ten thousand dollars per year for the most part.

Let's divide that by twelve, and that is eight hundred and eighty-five dollars per year in property tax. So then we go eight hundred and eighty-five dollars per month in property tax. The next cost with a home like this is going to be insurance.

Now what I generally find is that it's about one dollar per square foot per year for insurance. So let's just round that off to fifteen hundred dollars per year, one hundred twenty-five dollars per month in insurance. That actually seems kind of low, so let's just bump that up to one hundred and fifty dollars per month in insurance.

So you can see when you add all of these up, this works out to be forty-four hundred and eighty dollars per month in overhead cost with twenty percent down. Now, this does not also include repairs; it does not include vacancy or anything else that might come during your ownership of this.

Let's just say everything else considered; it's probably next to three hundred dollars per month, and that brings us to forty-seven hundred and eighty dollars per month. That's the cost right there.

The next thing we have to figure out is how much a home like this will rent for. So what I like to do is I go to my number one favorite website, which is craigslist.com. If you go over here to apartments/housing, you didn't go to the area—this is about mid-city here in LA price.

I'll just do three thousand minimum, because they know it's at least gonna be three thousand bedrooms—three bedrooms. Update search, and let's see if we can find something similar.

And there's not that many good ones that are actual houses. Oh, here we go! So here we go. Well, they call this a celebrity villa. Okay, whatever that means. Anyway, it's very similar, but it's renting for five thousand one hundred and ninety dollars.

But you can tell bigger square footage, more bedrooms, and doesn't look as updated, but still a pretty similar comp all things considered. So I would say, if this is renting for five thousand one hundred and ninety dollars, I think it's pretty safe to assume, and also based off my knowledge of this area, this house is probably gonna get somewhere around four thousand two hundred dollars per month in rent.

So we're gonna be getting four thousand two hundred dollars per month in rent. So you can see right now there's a big discrepancy between your cost here of forty-seven eighty and what you're gonna get every single month in rent.

This means that you're gonna be out-of-pocket five hundred and eighty dollars per month if you bought this property and rented it out. But this isn't the entire picture because it looks as though five hundred eighty dollars per month you're losing.

But let's go back to our mortgage calculator, and we see that every year you're paying down some of the principal because remember of your mortgage payment of thirty-four forty-five, a portion of that goes towards interest and a portion of that goes towards principal.

So every year you're making, let's call it, let's round it up to eleven thousand dollars in the first year. So you're making in profit eleven thousand dollars; that works out to be nine hundred sixteen dollars per month in equity.

Now, when you subtract your five hundred eighty dollar loss per month, that gives you three hundred and thirty-six dollars per month in equity, which is a little bit of profit. Now, this is a terrible example because it's in Los Angeles, and obviously very few things in Los Angeles ever tend to cash flow.

So if you're buying this for cash flow, you're doing a terrible job. You buy something like this for the equity and appreciation. But it's just to show you that even though you're at a loss every single month in terms of cash flow, you can actually make up for that in equity every single month.

Just assuming even the property value stays exactly the same, and doesn't even go up with appreciation, you're still coming out ahead about three hundred and thirty-six dollars per month. Then, thirty years from now, you end up owning this home entirely outright, and at that point, you could probably make a killing because rents in Los Angeles thirty years from now are gonna be absolutely stupidly expensive.

So as always, you guys, thank you so much for watching; I really appreciate it! Like I said in the beginning, if you enjoy content like this, make sure just to smash that like button; it does really help out a lot.

And if you watched this all the way through to the very end, if you haven't subscribed, you gotta subscribe. That's the rules! I don't—I don't make up the rules; we just have to. You have to abide by them! The rule is if you make it to the end of the video of mine and you enjoy it, just hit the subscribe button.

Also, hit the notification bell so YouTube notifies you anytime I upload a video like this; you won't miss out on that. Also, feel free to add me on Snapchat and Instagram; posts are pretty much daily. So if you want to be a part of it there, feel free to add me there.

And then, finally, if you're interested in real estate, real estate agent in wholesaling, just in basically anything real estate, I have a link in the description to a private Facebook group for real estate to anything. It's just a big group of real estate people, almost 5,000 people in there right now.

So anyway, if you want to join that, the link is in the description. Thank you again for watching, and until next time!