There are several primary “wealth generators” at play when you invest in buy and hold real estate:

Cash Flow. This is the extra income you’ll get to keep each month (or year) that you own the property. Cash flow can be deceptive because it fluctuates when certain repairs are higher or lower in different months, so it’s important to factor in non-monthly costs like vacancy (the amount of time the property sits vacant), repairs, capital expenditures (expensive projects that need to be replaced on a home every so often, like appliances, roofs, windows, plumbing, etc.), along with the regular expenses (utilities, management, etc.).

Appreciation. When the value of a property increases, we call this “appreciation.” While appreciation is not always guaranteed, over time, historically real estate has always increased in America, averaging 3% per year over the past century.

Another type of appreciation that can come into play is known as “forced appreciation,” the concept of increasing the value by physically improving the property.

Loan Pay-down. When you buy a property with a mortgage, each month your loan balance decreases. This means, over time, your tenant is essentially paying the loan down for you, helping you build wealth automatically. To make this concept clearer, pretend for a moment you owned a property that you bought for $1,000,000 with a mortgage for $800,000, and it made $0 in cash flow (it “broke even”) and never climbed in value. However, after that thirty-year mortgage is paid off, you’ll now have a property worth $1,000,000 that you didn’t actually save for. Your tenant paid it off due to the “loan pay-down.”

Tax Benefits. The final wealth generator from real estate are the tax benefits associated with owning property in the United States. The U.S. government likes real estate investors and uses the tax system to encourage our purchase and leasing of properties. From extra tax write-offs to the 1031-exchange and more, real estate investors can pay significantly less tax than other business owners, using the extra cash to buy more properties or pay off the loan faster — helping to build even greater wealth.

Leverage. Consider the common real estate purchase requirement of a 20% down payment – or $100,000 on a $500,000 asset. When a buyer puts only 20% of the money down, and borrows the rest, he or she is essentially using a relatively small percentage of his or her own funds to make the purchase. The majority is being provided by a lender. That’s why real estate investors often refers to the 80% remainder of the purchase price as “other people’s money.” It is in fact, being provided by someone else.

Assuming the property appreciates at 5% per year, the borrower’s net worth from this purchase would grow to $525,000 in just 12 months. Comparing this gain to the gain from a purchase made outright, without any loan, highlights that value of the leveraging strategy. For example, the same borrower could have used the $100,000 to make a paid-in-full purchase of a $100,000 property. Assuming the same 5% rate of appreciation, the buyer’s net worth from the purchase would have increased $5,000 over the course of 12 months, versus $25,000 for the more expensive property.

The $20,000 difference demonstrates the potential net worth increase provided through the employment of leverage. Now, picture that 5% gain every year for 20 years. Over time, the use of leverage can have a significant, positive impact on your net worth.

Other Strategies. Of course, different strategies in real estate will give you different benefits. For example, when you “fix and flip houses,” you are most likely will not get the benefit of the “loan pay-down,” nor are you getting cash flow, or certain other tax benefits.

Instead, flipping relies mostly on the “forced appreciation” you get by fixing it up. And flipping has the added advantage of not having to deal with “Tenants, Toilets, and Trash.” Get in, make your money, and get out. And because you are getting out quickly, you don’t have any ongoing tenant aggravations or risk. You get your money out, and can have it ready for the next great opportunity that comes along.

There are many great real estate wealth building strategies – from Buy and Hold, to Fix and Flip, to Wholesaling and beyond.

It’s up to each investor to determine which strategy is right for them. To learn more about what is required to be a Real Estate Millionaire, see our article on The Millionaire Mindset.