When acquiring a rental property, profits are derived from 3 main sources:
1. Cash Flow (rent payments made to you)
2. Appreciation (increase in property value)
3. Debt Reduction (principle paid back on mortgage)

Cash Flow
Money that is available to put in your pocket at the end of a year after all expenses have been paid.

Example
I purchased 3 yr. old investment property for 275,000 which currently brings in 1700/month in rent with 10% as a downpayment. My expenses are 1550/month.
- Mortgage payment 1260/month
- Taxes 250/month
- Insurance 40/month
Therefore, my profit is 150/month, that’s 1800.00 positive cash flow per year.

Appreciation
The increase in value of your property due to inflation.
Let’s assume that my property increases 3% per year by natural appreciation (last year it was 6% and this year the forecast is 4.5%). Therefore, at the end of the first year, my 275,000 property is now worth 283,250. That equates to a 8,250 increase in value.

Debt Reduction
The portion of the monthly mortgage payment that pays down the principle.
With the monthly mortgage payments of 1260/month, approx.500/month pays down the principle. This equates to approx. 6,000/paid down in the 1st year.

Summary
Profit is derived from Cash Flow 1800., Appreciation 8,250, and Debt Reduction 6000. Therefore 16,050 is the profit from the 32,000 investment (27,500 + 4500 closing costs). Now, other than the cash flow, this profit is not liquid cash unless we sell or better yet refinance after a year or so and do this all over again with another property. By the way, I forgot to mention that the rate of return for this is 50%, 16,050 divided by 32,000 = 50.16% rate of return on your investment.