A Brief Guide to Real Estate Income

When you invest in multifamily real estate, there are multiple ways to profit. There is the cash flow or real estate income that is generated from the property. This monthly income is created as rents come due and are distributed quarterly in our network. 

There is also the appreciation of the property as net operating income increases and the value of the investment grows. Investors see this benefit after a liquidity event like the sale or refinance of the property.

Also, real estate is highly tax-advantaged, so there are multiple ways to profit from investing while deferring or eliminating taxes that would otherwise be due with other investments.

Lastly, when a property is purchased with financial leverage, paying down that debt results in increased equity in the property. This amortization increases investors’ equity, and they see that benefit at a liquidity event. 

There are only so many investments that provide four distinct ways to profit. In this article, I want to focus on the real estate income one can derive from investing in apartments. 

What is Real Estate Investing Income?

When you think of the income generated from apartments, you probably think of rent. And, of course, rental income is the largest source of revenue. However, it’s not the only source. 

There are several other associated fees that you’ll encounter that can increase a property’s income. Things like:

  • Application fees
  • Parking fees
  • Utility fees / RUBS
  • Pet fees
  • Washer / Dryer income
  • Valet trash

When you add up all the rent collected and other sources of income, you arrive at the gross operating income (GOI).

When subtracting all usual and necessary expenses from GOI, you arrive at net operating income (NOI).

From NOI, you have to pay income taxes and debt service. It’s also wise to replenish capital accounts and reserves if you’re holding the property for the long term. 

The income left over after that is available to distribute to investors. This income is typically generated monthly and distributed quarterly. Some syndicators may opt to distribute monthly, biannually, or annually, but quarterly is the most common schedule you’ll encounter.

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Income-Producing Property Investments

Investing in income-producing properties can be a lucrative and strategic investment approach. By acquiring a rental property, investors can generate a consistent stream of passive income. 

When I write articles like this one, I focus on multifamily real estate for two reasons. First, it’s our investment platform and what we offer investors. 

The second reason is that multifamily real estate has consistently had the best risk-adjusted return and lowest volatility among all the commercial real estate property types. In experienced hands, multifamily real estate can be a stable investment with solid returns.

In another article, you can review the performance history of multifamily real estate vs. the other property types. But it’s important to recognize that while multifamily real estate may be the top investment category, it is not the only category.

The other main property types are:

  • Residential real estate 
  • Office
  • Retail
  • Industrial 
  • Hospitality

Other types of real estate outside the core property types are:

  • Land
  • Mixed Use
  • Special Purpose
  • Self Storage
  • Mobile Homes

In the right hands, any of these property types can generate profits providing one with real estate income. However, they all have different risk profiles; most are riskier than multifamily.

The toughest one for generating income is raw land. Typically land is a path of progress play. One buys in the direction of the way of progress and hopes to be bought out by a developer in the future. 

Since hold times can be significant and property taxes must be paid annually, some investors will seek ways to monetize their land. Possibilities include renting the land for farming or grazing or using it for boat or RV storage. 

Active vs. Passive Income with Real Estate

As I’ve discussed in other articles, most real estate investors would be better off as passive investors. Active investing should be reserved for those with experience and expertise or those with the time, energy, and inclination to become experts. 

Without the requisite knowledge to acquire, operate, and dispose of these properties, active investing is a trap where most either lose money or make less than they would have if they had invested passively alongside a professional. 

Passive investors have to share the profits with those experts, but in return, they don’t have to get their hands dirty with management duties, and they can leverage professional expertise to maximize their income and profits from an investment. 

Common Real Estate Income Streams

If you are looking for an additional source of income, real estate can be a great option. The steady cash flow generated from rental properties can provide a reliable stream of money, supplement your existing income, and be a pathway to achieving financial independence. 

You can purchase locally or invest far from your home when investing in real estate. 

You can buy an individual property, build a portfolio of properties, or invest in a diversified real estate fund

Many options are available to you that can offer additional income streams while driving long-term wealth accumulation. Through these real estate income investments, you can leverage your money, make smart financial decisions, and capitalize on the real estate market’s potential returns.

Residential Property Income

Resident-occupied real estate breaks down into two primary categories – residential real estate and multifamily real estate properties. Residential rental real estate encompasses one to four units. 

These are single-family homes, duplexes, triplexes, and quads. The real estate income collected from these tenants is used to cover the mortgage and other expenses associated with the property. What’s left over is the investor’s profits. But, small properties tend to yield small returns, so most people who go this route will want to develop a portfolio of properties. 

Unfortunately, residential real estate tends to be management intensive without the economies of scale that come with larger properties. Professional property management services are limited in this space, mainly leaving mom-and-pop owners who act as the property manager. 

Being bogged down with management duties can become a thorn in the owner’s side when they realize the real wealth in residential real estate comes decades later when the property is paid off. There won’t be mortgage payments at that point, and the property should have appreciated in value. This potential for capital appreciation enhances the overall return on investment.

Additionally, house flipping is another common residential topic involving purchasing properties at a lower price, renovating them, and selling them at a higher price for a profit. But, this tactic doesn’t create reoccurring income and places significant risk on the investor by not having rent from active tenants that can cover the cost of the mortgage on the home.

Multifamily Real Estate Investments

With the economies of scale that come with more significant properties, investors can pool their money together to buy high-quality properties in top locations.

They can also leverage the experience and expertise of professionals who operate these rental properties for a living. These professionals know how to optimize their investment, manage cash flow, minimize rental expenses, force appreciation, and execute a profitable disposition of the investment property in a reasonable amount of time. 

It is easy to see how investing in an apartment building with 200+ units would offer many advantages over managing even a fraction of that many single-family homes. 

To learn more about how to invest in high-quality, conservative multifamily real estate, schedule a time to speak with a member of the 37th Parallel Properties team. 

Short-Term Rentals (Vacation Homes, Airbnb, etc.)

When I began the resident-occupied real estate section, I said there are two main categories for generating real estate income – residential homes and multifamily apartments. That statement is true. However, there is a minor third category that I’ll label as other. 

This category includes income from trailer parks and short-term home rentals like renting a vacation home or having an Airbnb. Renting all or part of your primary residence can be profitable, but it involves mixing your investments with your personal life. 

For me, it’s not worth it. But if you decide to go that route, get professional advice on section 121 of the tax code. The IRS allows you to exclude gains from the sale of a private residence up to $250,000 for a single individual or $500,000 for a married couple. 

The kicker is that you must live in that home for two of the last five years. Depending on the time you rent the property, there are scenarios in which you could lose this significant tax break. If that happens, you might want to consider a 1031 Exchange

Commercial Real Estate Income

As discussed earlier, the leading commercial real estate property types are office, retail, industrial, and hospitality. While these property types may be more volatile than multifamily, many people derive real estate income from investing in these properties. 

It’s essential to be aware that many of these commercial property types are under assault from growing e-commerce (retail), the work-from-home trend (office), and Covid-19 (hospitality). For more information about these challenges, see the articles below.   

What the Decline of Brick and Mortar Sales Means for Retail Marketing

Large Offices in Major US Cities are the Most at Risk in CRE

Face of Hospitality in the Post-Covid World

Raw Land Investments

Raw land investing is highly speculative. In some ways, it’s similar to gambling. And it’s not easy to derive real estate income from land. Growth can be hampered by recessions, high-interest rate environments, onerous public policy, environmental concerns, and many other things. 

Hold periods for land can be significant, and your cash is tied up in a very illiquid investment that still has property taxes coming due each year.

Unfortunately, land is not depreciable, so there typically isn’t a way to defer those taxes either. Some people look for ways to rent the land for income while they wait to be bought out by developers. 

Additional Real Estate Opportunities for Income

I have noticed two common misconceptions while working in the real estate industry over the last twenty years. 

First, some people consider their primary residence a real estate investment. A person’s home is more accurately categorized as a personal asset rather than an income-generating property. 

Second, some people believe that REITs are direct investments in real estate. Therefore, I’d like to discuss REITs further in the next section.

REITs (Real Estate Investment Trusts)

An investment in a REIT is an investment in a company that owns real estate. Public REITs trade on the stock exchange, and when you invest in them, you invest in stock. 

It’s a stock market investment in the sector of real estate. It is not the same as purchasing direct real estate and receiving income from the tenants of that property. 

Consequently, the investor does not get the tax advantages of physical real estate. Like most stocks, REITs are highly volatile and correlate closer with the stock market than direct real estate. 

Now what I didn’t say is that REITs are bad investments. There can be many reasons why someone would want to invest in a REIT. But direct real estate is superior to a REIT if you’re looking for tax efficiency or diversification from a stock-heavy portfolio. 

How can we help?

Whether you’re an experienced investor or new to direct multifamily investing, we’re here to help.

We look forward to hearing from you.