Why you make money in real estate

What is money and why is it so important to us?

A metric is a unit that we use to measure. For example, if you wanted to know how far Miami is from New York, you would probably give an answer in miles, because a mile is a metric used to judge distance. In the same vein, a pound is a metric used to judge weight, and an hour is a metric used to judge time.

Money is civilization's metric used to judge value. We can measure how much you care about something simply by measuring how much money you would pay for it. This is why we use terms like "worth" and "value" in connection with money.

"But," you might protest, "the distance between New York and Miami doesn't change, yet the price of my latte is different every month." And, of course, you'd be wrong. The distance between Miami and New York is actually changing as the shape of the earth changes according to our rotation. But, in the end, that's all irrelevant. If an earthquake broke Florida away from the mainland and moved it 50 miles south, the distance between New York and Miami could still be measured in miles, it would just be about 50 miles greater.

Measurements can easily adjust to things that change, and few things change as quickly as our own minds. What's very important to us today might be nearly worthless tomorrow (bell bottoms, anyone?). But we still use money to measure how much something is worth to us. We show how much we care with our wallets. The stories these numbers tell aren't always politically correct.

For example recently oil troubles have driven up the price of gas. Americans, however, have shown how much they value transportation by continuing to pay higher and higher prices. We care much more about our ability to drive than, say, the victims of hurricane Katrina. Exxon earned almost $10 billion in profits in 3 months, which is more than 20 times as much as Americans gave to Katrina victims. Both of these articles were written in the fall of 2005.

Now I've gotten a little off topic here and my goal is not to rant about good or evil. In fact it makes a lot of sense to me that the average American would care more about transportation (by which he gets to his job and thus provides for his family) than the misfortunes of people he has never met that live thousands of miles away. In fact I believe that the amount that private Americans gave in the aftermath of the disaster was quite commendable (how it was managed is another story).

But the important thing is that money is our way of representing value. Your job pays you because the work you do provides value to them. You pay interest on your mortgage because of the value the bank gives you by letting you spend money you don't yet have. The lesson is clear, if you want to earn money you must provide value to someone.

I know this went down as a vague and philosophical post about the concept of money, but I feel it's important to properly label money before we can go about the business of discussing how to generate it. Tomorrow I'd like to reflect on the various ways investors can add value to a property and make money from it.