Have you ever thought about investing in real estate? Many people who have watched house flipping shows on TV might think it’s a quick way to get rich. While I’m a huge fan of real estate investing, unlike the tv shows, this isn’t a great way to “Get Rich Quick”. Further, flipping houses, in my opinion, is NOT investing (it’s more like owning a construction company where you are your only customer). True wealth built via real estate investing is typically slow and boring (not as sexy sounding, I know). Regardless, I believe everyone should at least consider investment property as part of their retirement plan. Here are 4 ways you make money with rental properties:
Monthly Cash Flow
The 1st way you make money with rental properties is the monthly cash flow. Cash flow is the money left over each month after paying all expenses. However, it’s not just monthly expenses you should have in the budget. You also need to save for long term repairs and maintenance such as roof replacement, HVAC, vacancy, insurance deductibles, etc. Building these costs into your plan means you’ll have the money when something goes wrong. This can turn a would-be emergency into more of an inconvenience.
Tax Savings
The 2nd way you make money with rental properties is through depreciation. Unlike the standard expenses you would expect to deduct for repairs and maintenance, the IRS also allows you to take depreciation. This means you can deduct a portion of the property’s value each year, over a long period of time (often 27.5 years). Depreciation is an expense you’re allowed to deduct even though you’re not paying for said expense out-of-pocket. That means even though you make a profit, you could still show a “paper loss” or “break even” when it comes time to pay income taxes. Check with your CPA, but in certain situations, you can even use “losses” from an investment property to lower your tax obligations from other income sources (i.e. from your W-2 job). Your CPA will also need to track the depreciation you take, because when selling an investment property, you may have to repay some of the savings you received by taking depreciation.
Property Value Goes Up
The 3rd way you make money with rental properties is when your property goes up in value. You can call it inflation or appreciation, but generally speaking, real estate in good areas is almost always worth more than it was 5 or 10 years ago. A house will require maintenance, but on average, the land itself will usually go up in value. A perfect example is when you see builders in Prairie Village tearing down houses from the 1940s-1960s just so they can build a new house on the same lot. That’s because the area is highly desirable.
There are many things that affect long term appreciation, but it’s 99% based on location, location, location. Corelated factors include crime, schools, and civic planning. Often times, proximity to downtown is important. Meaning, the further a property is from downtown, the less appreciation you will see (for example: small towns on the outskirts of the metro). Also note, there’s usually a negative correlation between cash flow and appreciation. Areas that cash flow well typically will not appreciate as well, and visa versa.
While appreciation one of my favorite ways to make money with rental properties, you should always consider it the cherry on top. Predicting appreciation is a gamble, so you should never use it as a primary factor when deciding to buy investment property. If the numbers require appreciation to make a deal work, you could be taking on more risk than you’d like.
Mortgage Payoff
The 4th way you make money with rental properties is by paying off the mortgage. Most real estate investors will purchase their investment properties using a mortgage, even if they could pay cash. That’s because using a mortgage (leverage) allows you to put down less of your own money, which amplifies your return. Keeping in mind, that the more leverage you use, the riskier the investment. All that aside, each year the mortgage is paid down little by little. The way mortgages work (amortization), you’re actually paying less interest and more principle each payment. In other words, your payment stays the same, but your mortgage balance decreases faster and faster each month until it’s paid off.
In Summary
The beauty of investing in real estate is the multiple ways you can make money. When high expenses reduce your cash flow for a period of time, you’re still likely benefiting from tax savings, appreciation and mortgage payoff. Now that you know the 4 ways rental properties make you money, would you like to know more? I’d love to discuss your options with you. Never any pressure; just a conversation!
Justin Rollheiser – REALTOR®
Keller Williams Realty | Diamond Partners Inc
13671 S Mur-Len Rd | Olathe, KS 66062
Direct 913-800-7653
Office 913-322-5878
www.JustinRollheiser.com
Comments or Questions?