The 5 Critical Components of Real Estate Investing Returns

Real estate is one potential piece of your asset allocation pie, so you should think about, and compare, its potential results against the same benchmark the finance industry compares its results: the 7-10% CAGR (compound annual growth rate).

When trying to predict what that CAGR might be, you will utilize these five critical drivers of your real estate investing returns: cash flow, principal pay-down, appreciation, tax effect, and renovation costs.

Cash Flow (Cash on Cash)

You collect rents, and out of that you pay the PITI (principal, interest, taxes, insurance) on your loan, then pay any management fees (if you are using property management), then pay any expenses that come up like repairs and/or maintenance—and what’s leftover is your net cash flow.

Principal Paydown (Amortization)

Every month as you cover your PITI, the “P” goes toward paying down your loan principal, so your principle balance is almost always going in the right direction…down. While this money doesn’t hit your actual bank account until a sale or refi, it is in fact income, to be realized down the road.

Appreciation

Throughout the timeline of a property’s ownership, its value in the open housing market may be going up or down. Like the stock market, the housing market has a long recorded history of performance.

When you sell, you pay tax on the gain you made on the property itself. You should always factor in potential sale tax when evaluating a property BUT, if you reinvest your proceeds into another rental property, via a 1031 exchange, you can kick the entire tax down the road again.

Tax Effect

Capital Expenditures (CapEx) & Renovation Cost

While also known as “capital improvements,” here’s what it includes: the money you spend improving your property that is not part of the usual “expenses and maintenance” of cash flow.

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