Four Income Streams

Contribute to Your Overall ROI

There are Four Income Streams that every investor needs to calculate whenever they are considering purchasing any property.

All too often, investors will solely concentrate on analyzing only the the Cash Flow Income Stream. But by doing so, they are not understanding the full picture of their total return on investment, or ROI.

One of the benefits of real estate investing is there are many different ways to realize a financial return, opposed to other traditional investments, such as stocks or mutual funds.

In order to calculate any return, you must know how much money total you are planning to invest. This will usually be comprised of your down payment, closing costs and any initial upgrades or repairs to the property. This is called your Total Investment.

The Four Income Streams available to you as a real estate investor are:

Cash Flow - As discussed at length in the Cash Flow section of this website, this number is calculated by subtracting all expenses from all income received. Dividing that number by your Total Investment will be your Cash Flow ROI.

Appreciation - This is the benefit received by owning a property and having it increase in value over time. Most investors use a 3-5% appreciation factor when calculating their ROI for this income stream. For example, multiplying the current value by 5% divided by your Total Investment will be your Appreciation ROI.

Taxes - When you own investment real estate, there are many ways to maximize your savings through the deductions the U.S. government allows you to take. While only a competent tax strategist should advise you on all of your available options, when you initially are researching property and trying to calculate your Tax ROI, there are two main ways you will receive tax savings:

1. Mortgage Interest Deductions - If you are purchasing the property with a loan, then you can deduct all of your mortgage interest at the end of the year.

2. Depreciation - The government actually assumes your property is decreasing in value each year, therefore over 27.5 years they let you write off a portion of the value of your property! This is a major tax savings to investors.

Calculate your Tax ROI by dividing your estimated tax savings by your Total Investment.

Principal Pay Down - Each month when you make a mortgage payment, if you have a full amortized loan (in other words, not an interest only loan), then a portion of that payment goes towards the principal (the original loan amount), which will reduce the amount you owe on the property, but which increases your equity. Determining how much of your monthly payment goes towards principal and dividing it by your Total Investment will give you your Principal Pay Down ROI.

When determining these income streams, you will be doing so on an annualized basis. So let's show an example to illustrate the power of this technique:

Let's assume you are purchasing an $80,000 home with a $20,000 Total Investment.

Cash Flow - You've determined based on the rent you can expect to receive less the monthly expenses that you will have a monthly cash flow of $350, or annually $4200. $4200 divided by $20,000 = 21% ROI.

Appreciation - If your $80,000 property appreciates 5% in value in one year, or $4000, divided by your $20,000 Total Investment, you will realize a 20% ROI.

Taxes - Per your Tax Strategist, you are expected to be able to deduct $4000 a year in tax savings, divided by $20,000 will give you a 20% ROI.

Principal Pay Down - Each month $100 of your mortgage payment is applied towards the principal loan balance, or $1200 a year. Divided by $20,000 is a 6% ROI.

So let's see what your Total ROI on this property would be if you decided to purchase it:

Cash Flow = 21%

Appreciation = 20%

Tax Savings = 20%

Principal Pay Down = 6%

TOTAL ROI = 67%

Compared to a measly 5-9% annual return most banks or mutual funds give, this demonstrates what a great investment real estate is when all income streams are factored!