Understanding How Real Estate Makes Money

Before learning Excel, valuation, or models, you must understand one simple thing:

“How does a property actually generate money?”

If this concept is clear then:

Modelling becomes easy
Valuation makes sense
Bad investments can be avoided

Two Main Ways Real Estate Makes Money

Real estate earns money mainly in two ways:

1️⃣ Rental Income (Regular Income)
2️⃣ Capital Appreciation (Value Increase)

Let’s understand both slowly and clearly.

1. Rental Income

What is Rental Income?
Rental income is the money you receive regularly by giving your property on rent.

Examples:

Flat → monthly rent
Shop → monthly rent
Office → yearly or monthly lease rent

👉 This is cash coming into your pocket regularly.

Simple Example

Monthly rent = ₹25,000
Yearly rent = ₹25,000 × 12 = ₹3,00,000

This ₹3,00,000 is your gross rental income.

Gross Income vs Actual Income

You may think: “₹3,00,000 is my income”

But real estate is not that simple my friends.

Here are the problems:

Property may stay empty
Tenants may delay rent
Expenses exist

Simple Example

Flat empty for 1 month
Rent lost = ₹25,000

So actual rent received:
₹3,00,000 – ₹25,000 = ₹2,75,000

👉 This is why vacancy matters in modelling.

Operating Expenses (Money Going Out)

Every property has expenses.

Common Expenses:

Maintenance charges
Property tax
Insurance
Repairs
Management fees

Simple Example

Annual rent received = ₹2,75,000
Annual expenses = ₹75,000

Now calculate:

Net Operating Income (NOI)

NOI = Rent – Operating Expenses
NOI = ₹2,75,000 – ₹75,000 = ₹2,00,000

Net Operating Income (NOI) – The Most Important Concept

NOI is the real income generated by a property before loan payments.

Why NOI is important:

✔ Used for property valuation
✔ Used to calculate returns
✔ Used by banks & investors

👉 NOI is the backbone of real estate modelling.

2. Capital Appreciation

Capital appreciation means increase in property value over time.

Example

Purchase price = ₹50 lakh
Value after 10 years = ₹80 lakh

Capital appreciation:
₹80L – ₹50L = ₹30 lakh

👉 This profit comes only when you sell.

Now Combining Both: Real Profit in Real Estate

Real estate profit = Rental Income + Capital Appreciation

Full Example

Annual NOI = ₹2,00,000
Holding period = 10 years
Total rental income = ₹20,00,000

Purchase price = ₹50 lakh
Sale price = ₹80 lakh

👉 Total Profit = ₹20L + ₹30L = ₹50L

Cash Flow Concept (Beginner Friendly)

What is Cash Flow?

Cash flow = Money left in your hand after all payments

Types of Cash Flow:

Before Loan (Unlevered Cash Flow)
After Loan (Levered Cash Flow)

Example with Loan:

NOI = ₹2,00,000
EMI per year = ₹1,50,000

Cash flow:

₹2,00,000 – ₹1,50,000 = ₹50,000

👉 This ₹50,000 is actual money you earn yearly.

Money Flow in Real Estate
Tenant → Rent → Expenses → NOI → Loan → Cash Flow → Investor

Income Property vs Non-Income Property

Income Property

Rented flat
Office building
Shops

💡 Generates regular cash flow

Non-Income Property

Self-occupied house
Empty land

💡 Mainly depends on appreciation

Mini Case Study: Rent vs Appreciation

Case A: High Rent, Low Appreciation

Rent = ₹30,000/month
Price growth = 3%

Case B: Low Rent, High Appreciation

Rent = ₹15,000/month
Price growth = 7%

❓ Which is better?

👉 Answer depends on your goal, and this is exactly why financial modelling is needed.

Key Takeaways of this post:

Real estate earns money from rent + appreciation
Rent is not equal to profit (expenses & vacancy matter)
NOI is the most important income measure
Cash flow is what investor actually earns
Different properties suit different investors

What Comes Next?

In the next chapter, you’ll learn:

All important real estate terms
Words used by professionals
Terms you must know before touching Excel