Buying Rental Property and Real Estate has helped create many a millionaire. Robert Kiyosaki, Barbara Corcoran, and even Donald Trump amassed fortunes via Real Estate.
Buying rental property is an investment that hits on three out of five of my Investment Goal Categories: Capital Appreciation, Preservation of Purchasing Power and Passive Monthly Income.
At it’s most basic level, investing in rental property consists of buying a property and then renting it out to gain monthly income.
I don’t directly own any rental property at this time but it is an area I’m investigating and learning more about.
Buying Rental Property has Five Great Benefits
1) Passive Monthly Income (Cashflow)
2) Equity Build-Up
3) Leverage Utilization
4) Very Favorable Tax Benefits (in the US)
Let’s explore the five benefits of buying rental property.
Passive Monthly Income
In many areas it’s feasible to purchase a rental property that generates positive cashflow each month. Even after making a monthly mortgage payment, taxes, fees and maintenance expenses, a good rental property can be have net positive cashflow from the rent payments of the tenants.
This meets one of my investment goal categories of passive monthly income.
Many banks will loan qualified persons enough money to purchase a rental property but typically require a 20-30% down payment. By renting the property you can use the rental income to pay the mortgage and continue to build equity in the property until you own it outright.
With equity in a property you have the option to choose between selling the property, taking a loan out on the property and re-mortgage it, or simply hold onto the property and continue to enjoy the monthly income.
By taking out a loan to buy a positive cashflow rental property you are leveraging the capital you have to make more money. For example by using $16,000 for a down payment you could purchase an $80,000 property and rent it for $600 per month. Lets say after making the mortgage payments, paying property taxes, and other expenses, you are bringing in $150 per month in cashflow. At the end of the year that $150 monthly income would be $1,800 from a $16,000 investment, or over an 11% return. And that doesn’t even include the increase in equity.
Because of the use of leverage, price inflation actually reduces the cost of the remaining loan balance over time. This combined with the universal human need (and hence demand) for shelter even when the economy is not performing well makes buying rental property a great investment for preserving purchasing power.
I’m not a CPA or tax advisor, but I understand that when it comes to investment properties, mortgage interest, depreciation of the property, and other expenses that go into maintaining the property are tax deductible. Often times the 11% profit can be made tax free because of all the deductions the tax code (at least in the US) provides to real estate investors.
Partly due to price inflation, partly due to an increasing population and demand for housing, real estate prices tend to rise. So it is possible to grow wealth because the value of the property has gone up. While this is more on the speculative side of the housing and real estate market, appreciation can be a very nice bonus.
This meets one of my investment goals of capital appreciation as well as preservation of purchasing power.
What has stopped me from Buying Rental Property in the past?
- Capital I need money for a down payment. Most of my savings go into stocks and I want to buy a rental property with new money. So I’m going to start earmarking money for buying rental property. While it might be possible to buy a property with zero down I think this is reckless and irresponsible. It’s a good way to find yourself underwater on your mortgage. By making a 20% down payment you can weather a 20% drop in the value of the property and still be even in terms of equity. Plus if the property is cashflow positive, even if you are not making money via appreciation, you can still make money via cashflow and equity building.
- Knowing how to make an offer I would like to better learn how to coordinate having a loan pre-approved with making the offer. With real estate you have to be able to move quickly. In some markets if you go eat lunch to think it over the property will be sold by the time you get back.
- Maintenance Costs and Expenses If you know purchase price of a property and how much you can rent it for (by looking at similar properties being advertised in the same area) and what your costs are going to be you can determine if a property will be profitable (or not). However, I find the most difficult part to research is estimating maintenance costs. The hot water heater breaks, furnace needs repair, a crazy tenant tears up the place, etc. As someone who has been a renter all his life I don’t have a good sense of how much I need to budget for maintenance costs for a rental property. These costs are a huge factor in the profit and loss calculations.
There are five great reasons why real estate investing is a superb way to build and grow wealth. I’ll be sharing my progress in the coming months as I continue to learn more about real estate investing.
This is a good introduction article. I own one rental property and am an investor on a few new construction projects. I would say real estate is not something to get into lightly. If you do it wrong not only can you lose much of your investment, you can also be sued. Anyone looking to get into real estate investing should start with reading as much as they can on BiggerPockets, books, and attending their local real estate investor groups.
The absolute most important thing you can do is buy correctly. Everything else comes secondary because you make your money when you buy real estate, not when you sell. So figure out how to run the numbers and always run a deal through your calculator to make sure the deal fits your needs. A good rule of thumb I use to buy rental properties is (monthly rent / (purchase price + repairs)) >= 1.5%.