Real estate profit center #2: Amortization
Amortization is the concept of paying down your debt service. It is phantom income because you don’t get the money in your pocket each month, but your equity grows with each payment you make—and because your rental income covers the debt payment, it is income to you. Let me explain further. Each month, when you make your debt payment (or rather your tenant makes your debt payment) out of your NOI, a portion of that goes towards paying down your principal on the loan. When you hear somebody talk about a 30-year fixed fully amortized loan, it means that when you make all 360 of those monthly payments at the end, the loan is 100% paid off. Because your tenant is paying rent, and that rent is covering the debt payment, the principal pay down included in that debt payment is profit for you. Let's take a look at how this plays out with our $144,000 loan from above. In the first year of the loan, you'd be paying $4,583.33 in interest and $2,529.54 in principal. As the loan matures, the interest amount goes down each month and the principal amount goes up. But we'll use these numbers for now. That $2,529.54 is profit to you. It's true equity in your property. If we add this $2,529.54 to the $4,236 in operating income, we now have $6,765.54 in income for the year, an 18.8% return on our $36,000 invested into the property. Plus, your interest payment is often tax-deductible, it’s an added bonus but check with your tax advisor to be sure for your specific case. Already, you're crushing average stock market returns and there are still two more real estate profit centers to look at.
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