One of the most common questions we hear from investors is, “How do I know if I’ll make money on this real estate investment?”
Closely followed by, “How much money will I make?”
Which are fair and important questions to ask. If you’re thinking about buying an income-producing property, you need to understand where the returns are coming from. Too often, new investors jump in without a clear picture of how the numbers work or what to expect.
There are four main ways that real estate creates value over time. These are the things you should evaluate before going into any deal.
1. Cash Flow
Cash flow is the income that’s left over after you’ve paid all the expenses on a property. That includes mortgage payments, taxes, insurance, utilities (if you cover any), management fees, repairs, and reserves.
A lot of investors forget to prioritize cash flow from the beginning. They might be drawn to the potential appreciation or the tax benefits, and those things do matter. But if you don’t have enough cash flow to cover basic operating needs, you can end up in a difficult situation.
You might be building equity on paper, but if you don’t have actual cash coming in each month, it becomes harder to cover maintenance costs or unexpected expenses. Nobody wants to go into the red because they need to repair the roof. Real estate is a long-term investment, and having positive cash flow makes it much easier to stay in the game.
2. Appreciation
Appreciation is the natural increase in property value over time. In most markets, real estate tends to at least keep pace with inflation, and real estate exceeds it in some cases. That’s part of what makes real estate such a useful hedge against inflation.
But it doesn’t stop there – you also have the ability to force appreciation.
If you increase the income on the property by raising rents, improving tenant quality, or reducing expenses, you increase the value of the asset. That’s especially true with commercial and multifamily properties, where value is directly tied to net operating income.
Many investors focus on this strategy because it allows you to create equity faster. You’re not just waiting for the market to improve, but you’re actively taking steps to make the property more valuable through better management and smart improvements.
3. Principal Paydown
The third source of return is something investors often overlook: principal paydown. When you use financing to purchase a property, you’re going to be paying that loan down over time. But for an investment property, the best part is that your tenants are the ones making the payments.
Each time a rent check comes in and your mortgage payment gets made, a portion of that goes towards reducing your loan balance. Over the years, that adds up. Eventually, the mortgage is either paid off completely or the balance is significantly reduced when you go to sell. It’s a steady, reliable way to build equity without having to do anything extra. And even though it’s not always front and center in investment projections, it’s a key part of how real estate builds wealth.
4. Tax Benefits
Real estate income is taxed differently than earned income – you don’t pay Social Security or Medicare tax on rental income. But what really sets it apart as an investment is depreciation.
Depreciation allows you to write off part of the property’s value each year as a non-cash expense. That reduces your taxable income on paper – even if your cash flow is strong in reality. For many investors, that means paying little to no income on their rental profits. And if you’re able to take advantage of bonus depreciation, you may be able to create even larger passive losses that help cancel out other income.
On top of that, when you eventually sell, the gains are taxed at capital gains rates, which are typically lower than your regular income tax bracket.
Conclusion
When someone asks how much money they’ll make on a real estate investment, it’s easy to focus on the market rent rates. But that’s only one piece of the puzzle. The real strength of real estate is that it gives you multiple ways to build wealth at the same time. You’re collecting income, increasing value, paying down your principal, and doing it all with tax advantages that most other investment types don’t offer. Keep these in mind and you’ll have a much better sense of how your investment is performing now and what it can do for you over the long term.
Want help evaluating an opportunity or understanding how the numbers work? Reach out to our expert advisors for a consultation. We’re always happy to help.
