Residential real estate is a proven money-maker. As a flexible asset class, there are many ways to make money in residential real estate. Whether you’re an experienced investor looking for new ways to earn passive income, or a new investor, looking to maximize your income potential, this article will highlight industry insider tips for making money in residential real estate.
Ways to Make Money in Residential Real Estate
There are four primary ways to make money in residential real estate.
Appreciation simply refers to the value growth of an asset. As your real estate becomes more valuable, your net worth increases.
Appreciation can either be organic or forced. Organic appreciation is called “market appreciation.” This is when general economic conditions drive property values up over the long term. Forced appreciation is when you add value to a property to immediately increase its worth.
Your gains are unrealized until you sell the asset for a profit. When you sell the property, you realize your value gains and can pocket the proceeds or reinvest them. But even before you realize the gains, you benefit from appreciation thanks to equity.
Equity is the value you own in your property. You can calculate your equity by subtracting any debt owed on the property from the property’s current value. In theory, this is the amount you stand to make on the sale of the property (minus closing costs). Simply having equity is valuable because you can convert a portion of your equity to cash, through financial tools like home equity loans and home equity lines of credit (HELOCs), which can be used to improve the property or even make a down payment on another property.
2. Rental Income
One of the primary benefits of investing in residential rentals is the power to earn passive income from real estate. Assuming that your rental rates are enough to cover your property expenses (such as mortgage payments, property taxes, insurance, and maintenance), you’ll see positive cash flows regularly throughout your holding period.
Even better, once the mortgage debt is repaid and this primary expense is eliminated, your cash flows will increase substantially!
Your passive rental income can be used to supplement your earned income, finance your lifestyle during retirement, or fund additional investments to grow your wealth.
In fact, if you choose to pass your rental properties to your children, you can create generational wealth to ensure that your children and grandchildren are provided for.
3. Dividend Income
Dividends are simply periodic payments made to investors based on the financial performance of a portfolio. Dividend income is a special way of making money in residential real estate that doesn’t require direct property ownership.
There are several ways to invest in real estate without buying property. Take REITs (Real Estate Investment Trusts)for example. REITs are companies that invest in income-producing real estate (many specialize in commercial real estate, but there are also REITs that focus on residential real estate). Investors can purchase shares of a REIT and receive a portion of the company’s proceeds in the form of dividends.
As with rental income, dividend income can be used to supplement earned income, finance retirement, or advance your investment portfolio.
4. Tax Benefits
Income tax savings might not immediately come to mind as a way of making money in residential real estate, but a penny saved is a penny earned, and the tax benefits of real estate investing can add up to a lot of pennies!
Not only are your operating expenses generally tax deductible, but rental property owners can also take advantage of depreciation deductions. This is a complex topic (please read our article on how rental property depreciation works to learn more), but basically, depreciation allows you to deduct a percentage of the property’s value over the course of its “useful life.”
For context, if you have a property with a $716,000 cost basis, you would likely take $26,036 in annual depreciation because the IRS has determined a useful life of 27.5 years for most real property. If you are in the 22% tax bracket, this would give you an annual income tax savings of $5,728!
Specific Strategies for Making Money in Residential Real Estate
Given the four primary methods of making money in residential real estate, let’s explore a few specific strategies, designed to take advantage of one or more of these methods.
1. BRRRR (Buy, Rehab, Rent, Refinance, Repeat)
The five-step BRRRR strategy was created to help investors build a real estate portfolio quickly. Step one is to purchase a property in need of renovation. Then you renovate the property to force appreciation and build immediate equity before renting the property to qualified tenants. When the property is stabilized, meaning that all unit(s) are occupied and you have established proven cash flows, you can refinance the original loan to a long-term mortgage. Importantly, because the equity increased through the renovation, you may have enough equity to pull cash out of the refinance, which you can use to fund your next acquisition.
The refinancing to pull out your initial investment is key as it allows you to essentially re-use your initial investment over and over to grow a portfolio of rental properties.
Through BRRRR, you benefit from the appreciation of your assets, rental income from all the units in your growing portfolio, and tax benefits from each property.
2. Add Value with ADUs (Accessory Dwelling Units)
ADUs are additional housing units added to residential properties. Also known as guest houses, in-law suites, casitas, and granny flats, ADUs can be stand-alone structures or converted areas of existing structures (like attics, basements, or garages).
ADUs have exploded in popularity as many local governments have streamlined the permitting process in an effort to create additional units of housing amid local housing shortages.
You can make money by building an ADU on the lot of your primary residence or adding an ADU to an investment property.
Not only will this force appreciation by adding value to the property, but it can also be rented out for a separate income stream (if you’re planning to hold the property rather than sell it immediately). You may also qualify for tax benefits from this addition. Check with your tax accountant to confirm the potential tax benefits, given your unique financial situation.
3. Go BTR (Built to Rent)
The build-to-rent (BTR) strategy is another increasing trend, driven by the lack of affordability in the housing market. As more would-be buyers are getting priced out of the housing market, they are looking for long-term rentals that feel more like a home than an apartment. BTR properties. BTRs can be single-family homes or multi-family structures, like townhouses or even condo-style apartments.
The idea is to build units that will perfectly suit long-term renters in your local market. This might mean including private outdoor spaces for each unit. Or using higher-end finishes than you would use in a standard apartment building. In family-friendly neighborhoods, this might mean making units with four or more bedrooms to accommodate growing families.
BTR properties enjoy forced appreciation from the construction phase, as well as long-term appreciation over time. They also make money from rental income and tax breaks.
4. Consider Short-Term Rentals
Short-term rentals (often used as vacation rentals) can be a strong option for investors who want to maximize their nightly rental rate. Many investors also like the idea of being able to use the property themselves when it’s not booked, or even allowing family and friends to stay at the property between paying guests.
When considering a short-term rental vs. a long-term rental, pay special attention to the following local factors:
- Demand for short-term rentals (and seasonal changes in demand).
- Any local regulations governing short-term rentals.
- The time, effort, and money required to manage the high turnover of guests and their expectations for a clean, well-stocked accommodation.
When managed properly, short-term rentals provide appreciation, high rental income potential, and tax benefits.
5. Invest in Crowdfunded Real Estate Projects
As the cost of real estate has dramatically increased since 2020, more investors are struggling to fund properties on their own. Instead, they are turning to crowdfunded investment opportunities to make money in residential real estate. By pooling your funds with money from other investors, you can own a share of a high-value real estate deal for under $25,000. Compared to the cost of a down payment, renovation/development, and ongoing operating expenses, this is a steal!
Plus, crowdfunded projects are professionally managed by a team of industry experts. This allows you to leverage their knowledge and skill to maximize your return potential without the hassle of handling the details yourself.
Crowdfunded real estate deals can include a wide range of residential project types, including single-family flips, multi-family development, and even multi-family built-to-rent.
Your options for making money in residential real estate crowdfunding depend on the project type you choose. Fix-and-flips, for example, would give you forced appreciation profits, while rental properties would give you rental income and long-term appreciation. Some crowdfunding platforms will pass the tax benefits on to investors, while others won’t (this is one of many factors to consider when choosing a real estate crowdfunding service).
Quick Tips for Making Money in Residential Real Estate
Before you place your next real estate investment, consider these quick tips for maximizing your money-making potential:
- Purchase with intention. Don’t buy a property without a plan. Establish your goals for the investment before committing. This also means having an exit strategy in place. How will you sell the asset when you’re ready?
- Remember that it’s always the right time to buy. Attempting to time the market can result in missed opportunities; there are simply too many economic factors at play to know when markets will peak or bottom out. Instead, invest when you can, knowing that real estate values always rise over the long term.
- Do your research. While it’s always a good time to buy, some investment strategies will perform better than others under different market conditions. It’s common for professional investors to analyze dozens of properties before choosing one to pursue.
- Think like your target market. Put yourself in the mindset of your prospective renters or buyers. What are they looking for? What are their concerns? How can you meet their needs and exceed their expectations?
- Leverage industry experts. Those who invest in their spare time can’t have the same level of knowledge and experience as the industry professionals who invest for a living. Take advantage of these experts! Enlist real estate agents, mortgage brokers, and real estate developers as needed to make the most of your project. Or join a crowdfunded project in which the deal’s sponsor already has these connections lined up and ready to work for you!
Make Money in Residential Real Estate with Gatsby Investment
If you’re ready to make money in residential real estate, but you’re uncertain about the best way to proceed, consider investing in a crowdfunded project with Gatsby Investment.
Gatsby offers a wide range of residential real estate investment opportunities, including both long-term and short-term options. We have a strong track record of earning annualized returns of over 20% on average. And, with our transparent online platform, you can invest with confidence, knowing that you will have access to financial information and progress updates at each phase of your project.
Learn more about investing with Gatsby Investment and get started today!