Investing in houses is not a get rich quick scheme, it requires sound strategy, a focused plan, and perseverance. Having said that, home investors who invest wisely tend to experience a gradual, then an exponential, growth in wealth. Despite this, inherent dangers lurk in every deal and these risks must be weighed against home investing revenue advantages like price appreciation, tax benefits, and passive income. This article will detail the ways houses can generate income and how home investors make money in the context specifically of its author, Good Vibes Homebuyers.
What’s in it for you
How much do house investing businesses make in a year? What about in a month? The answer to those questions can vary wildly and depends on the size of a homebuyer’s portfolio but even more so on an investor’s investing strategy. This section covers the most prevalent methods house investors have used to make money.
Due to the prevalence of home improvement reality TV shows, when folks think of making money through real estate, fix-and-flip is often the first strategy that comes to mind. What’s portrayed on your home’s TV screen is, however, rarely reality as fixing and flipping houses represents the highest financial risk. Perils aside, property flippers are home investing companies or individuals who specialize in buying low and then paying for and making high-return fixes and improvements in a short time so that they can then sell the house on the open market at market price.
Making investment money through rent houses is typically the second strategy that folks think of and unlike appreciation, rental income is regular and easily accessible. In short, buy and rent home investors receive a fixed payment from tenants each month and after paying all expenses, the amount remaining represents a home investor’s passive income. The problem, at least in central Texas, is that practically no rent homes produce passive income during an investors initial 5 to 10 years of ownership. After this period, however, home investors often earn passive income because rents typically will have increased while the mortgage payment has remained constant.
Investment real estate historically has appreciated which is when property values increase over time or through forced appreciation (the concept of renovating a property while decreasing its expenses to force values up). Appreciation is most often the greatest source of home investing wealth, its problem is, however, that gains through appreciation cannot be realized without selling or refinancing. Nonetheless, the magic of appreciation over time is, as Albert Einstein famously once said, the “eighth wonder of the world” because it compounds. And compound interest is absolutely confounding (below example uses 5% annual property appreciation):
Refinancing houses can provide investors with multiple streams of income that arrive in various ways. For instance, refinancing to a lower interest rate decreases a home’s monthly mortgage payment and thus increases investor cash flow. Another option available to investors who make money through refinancing is a cash-out refinance. In this scenario, investors with more than 25% equity can increase cash reserves by refinancing to increase debt on a home up to 75% of its value. In so doing, they pocket the difference between a home’s pre–refinanced equity and the refinanced amount. For astute and wise home investors, both scenarios – increased cash flow and a cash reserves surplus – are possible.
IRS tax code section 1031, commonly referred to as the ‘1031 exchange rules’, is a legal loophole that investors have used to generate both massive passive profits and to acquire higher value investments that expedite the growth of wealth through compound appreciation. In short, 1031 exchange rules allow home investors to defer paying taxes on the sale profits and to instead use 100% of those profits to buy a new investment. In so doing, home investors increase their available capital for the requisite investor 25% down payment (to a bank) which allows them to subsequently acquire higher value assets:
Instead of flipping houses, this type of flipping to profit from homes involves companies or individuals, known as wholesalers, who get homeowners to sign a sales contract and then transfer those purchase rights to a real homebuyer for a fee. In short, wholesalers are largely unnecessary middlemen who profit off homeowners without adding real value to them. Important to note is that Good Vibes Homebuyers are not wholesalers and never will be and we have a plethora of articles on how to snuff out home contract flippers who try to make money off unsuspecting homeowners.
As home investors who regularly buy directly from Texas home owners, we’re frequently asked questions like: “What type of buyer is Good Vibes Homebuyers?”, “how do your house investors make money?”, “what would your profit be out of the deal you offered me?” This section sheds light on those questions and provides readers with a good understanding of the ways our investors generate income through houses.
Good Vibes homebuyers has been in business since early 2019 and is a rental home investing business with more than 30 central Texas rentals. As such, money generated from our rent house portfolio represents roughly 30% of our income. Here’s an example of how it works:
Purchase price: $200,000
Rent rate: $2,500/month
Expenses: $1,300/month
Net operating income: $1,200/income
Debt service: $1,135/month
Cash flow: $65/month
Easily inferred from the above example is that renting houses to make money is not a big pay day and in fact most single-family rental homes will not produce positive income during an investor’s first 5 to 10 years of ownership. Over time, however, 2 significant things to an-investors-bottom-line occur: (a) the debt service (mortgage payment) stays the same while the (b) monthly rent rate increases. Instead of an investor earning $65 each month as in year 1, in year 10, for example, an investor’s monthly cash flow would be:
Purchase price: $200,000
Rent rate: $3,360/month
Expenses: $1,750/month
Net operating income: $1,610/income
Debt service: $1,135/month
Cash flow: $475/month
*assumes 3% rent and expense rate growth
Flipping homes to earn money is our investors least preferred strategy because it involves the most risk and demands the most time. Nonetheless, on occasion, we do renovate and quickly flip homes on the open market. As such, money produced from flipping homes represents just 10% of our investor’s profits. Here’s the formula that all investors use for flipping homes and below is an example of how it works:
After repair value: $350,000
Fixed costs: $70,000 (20%)
Rehab expenses: $40,000
Flip profit: $35,000 (10%)
Purchase price: $205,000
A home investor making a $35,000 profit doesn’t seem like too bad of a deal. Right? From our perspective, it’s typically not worth it! In addition to the inherent risk and time demanded of our investors to flip homes, there are severe negative tax implications that result in flippers having to pay upward of 50% in taxes on all gains.
Since our beginning in early 2019, we’ve not taken any profit out of our business. This isn’t to say that there hasn’t been any profits, but instead to say that all profits have been reinvested back into the business because its gains to-date have not yet been sufficient. And we’re ok with that because we know that how home investors make significant profits is through having a long-term strategy. As such, our investing in homes business stands to make its most notable gains through house appreciation.
Important to clarify is the word “gains”. In short, gains are not regular and recurring income. Instead, gains are illiquid and take time, effort, energy, coordination, and the approval of others, (e.g., banks) to be able to turn those gains through appreciation into cold hard cash. As of the present, investing in homes to make money through appreciation has represented just a small fraction of our income. In the future, though, this way for our investors to make money will undoubtedly represent the majority of investor profits through either selling or refinancing.
Refinancing investment houses to access cash is our bread-and-butter with it representing roughly 60% of our investor’s profits, today. Tomorrow (as in about a decade), creating cash through refinancing assets within our rental portfolio will account for the vast majority of gains. Why must we wait to refinance? We must have at least 25% equity because banks will loan only 75% of an investment’s property value. Here’s how it works in, for example, 10 years and assuming 5% annual appreciation:
Market value, 2023: $210,000
Mortgage balance, 2023: $200,000
Market value, 2033: $342,070
Mortgage balance, 2033: $164,700
Equity, 2033: $177,370 (48%)
Max allowed refi, 2033: $256,555 (75%)
Cash out refi, 2033: $79,185
2 magical things are happening when home investors create money through refinancing: (a) all refinance proceeds are tax-free and the (b) investor maintains control of the asset but also a strong equity position. Because of this and using our example, investors even have an additional option for making money: (c) they could sell and create an additional estimated 15% ($51,310) profit. To some profitable home investing companies, selling after refinancing may be the ideal exit strategy, for us as long-term investors who prefer to hold properties for decades however, we will most often enjoy the refinance proceeds in conjunction with the continued monthly rental home cash flow.
1. Can beginners make money by home investing?
Ironically, if your reason for wanting to be a home investor is to make money, you’ll find that the opposite will probably come true. Your reason must be more than financial and making money by investing in homes requires a plan, sticking to that plan, and tempering expectations. It’s not a get rich quick scheme but it is a great way to consistently grow wealth and hedge against inflation.
2. What is the historical average rate of home appreciation?
According to the FHFA, the average annual home price increase throughout the last 30 years has been 4.3%. Since 2000, the average rate of appreciation has been 4.7%. And since 2012, home price appreciation averages 7.7%.
3. What’s another way home investors make money?
There’s many different paths to profiting from real estate, but 1 lesser-known strategy that we use is known as a “wraparound mortgage,” which is a creative form of owner financing. Learn how our home investors use this strategy to benefit sellers and generate income.
Home investors who have figured out how to produce consistently positive gains are a dime-a-dozen. Investing successfully in real estate is hard, uncertain, and not for the faint of heart. At the same time, anyone can invest in real estate, and many have but few have done so profitably, often cutting corners, undercutting sellers, and operating (hopefully) unintentionally in poor faith due to ignorance. As our portfolio has grown, so has our ability for creating deals that maintain our bottom line but more importantly which meet the goals of sellers. Don’t underestimate the value of experienced home investors who know how to create profitable deals for a seller and buyer. Contact us today for the best guaranteed offer on the market!
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