Why Rental Property Is A Powerful Asset Class
From a financial standpoint, rental property is at the top of the list of assets to own. It can soon become the biggest headache if you don’t screen properly for the right tenants or buy in a location which consistently attracts poor tenants. Good thing you scre eRb402HI en like the CIA and only buy in prime locations.
Rental property is the ultimate hedge against inflation as well as the ultimate asset to make money during inflation from a cash flow and real asset appreciation perspective. With the US Dollar going into the crapper, your goal should be to borrow as much USD as your personal balance sheet allows and buy a real asset in an appreciating foreign currency! If you can’t do that, you just have to do the next best thing and buy American. The foreigners are coming!
MAKING MONEY EVERY WHICH WAY AND SIDEWAYS
Declining Inflationary Environment
Let’s say you have one million dollars sitting in the bank earning 2% interest from a long dated CD shall we? Every year, you earn a respectable $20,000. You used to be able to earn $42,000 a year, but thanks to the downturn, inflation is nowhere to be found. During a low inflationary environment, your rental property INCREASES in value. Let me explain with some realistic numbers.
Rents are sticky for the most part, and trend up and to the right. Over the past two years, one of my rentals’ has seen rent go from $3,000 to $3,100 a month. Not that impressive, however you have to compare the rental yield with what risk free rates have done in the same period. 5 year CD rates have plummeted from 4.25% to around 2% during the same time frame. If you capitalize the rental value, you simply take $3,100 X 12 months = $37,200 divided by 0.02% = $1,860,000. In other words, if I had no mortgage and no expenses, at a 2% cap rate, my rental property is suddenly worth $1,860,000 from under $1,000,000 when rates were at 4%.
When 5 year CD rates were yielding 4.25%, the $37,200 annual stream of rental income was worth only $885,714. in other words, in this low interest rate environment, you need to have $1,8650,000 in a 5 year CD yielding 2% to generate $37,200 in income. The importance here is cash flow and opportunity cost.
Increasing Inflationary Environment
As inflation, and therefore interest rates start ticking up you have a commensurate uptick in rent and property valuation as well. Inflation is only bad if you don’t have real assets. If you have zero real assets and just cash, the stuff you buy is inflating higher in prices while your dollar loses its buying power, thereby hurting you. In an inflationary environment, your rental property increases in value by definition, often times by a rate much quicker than the Consumer Price Index as we saw in the bubble!
As a landlord who has a mortgage, the large part of your costs are fixed due to a fixed rate mortgage. Your insurance, property tax, and maintenance costs will creep higher, however these costs generally account for no more than 25% of total costs. During an inflationary environment, there is upward pricing pressure on rents. As a result, you simply follow the market higher and raise the rent to a level where the market can bear.
Back to our example of capitalization rates. You might be asking, ‘Isn’t it bad if cap rates go up, since you’re underlying value goes down in the example of 2% to 4%?” Yes, it’s bad from a balance sheet perspective, but from a cash flow perspective, you are loving it. With rental property, your #1 concern is cash flow generation. Only when its time to sell your asset, do you care about the underlying value.
Since we are in an inflationary environment and CD rates are ticking higher, your responsibility as a landlord is to raise your rent accordingly. You must be vigilant every year in following the market, or else you will lose out on a relative basis. In a 3%-4% inflationary environment vs. our 1.5%-2% environment now, I will raise my rent by 3-4% per annum. In 5 years, my $3,100/month in rent will jump to $3,682/month if I increase the rent by 3.5% every year. In order to calculate the capitalized value of my rent I simply take $3,682 X 12 = $44,184 divided by 4% = $1,104,600 as one means of valuing what the rental property is worth.
Zero Inflationary Environment
In this unlikely scenario, nothing really changes except that every month you are paying down your debt so that one day, you will own the rental property free and clear. You are using other people’s money (OPM) to own an asset and other people’s money to service the debt. For the bank and the renter’s troubles, you provide them a payment and shelter in an exchange deemed fair by both parties.
DEVELOP MULTIPLE ASSET CLASSES
There’s no such thing as passive income. You’ve got to work for everything for the most part. Rental property is a wonderful asset class to own during the good economic times and the bad economic times. Here in San Francisco, rental prices where out of control with people queing out the door during the Internet Bubble because companies where hiring like mad. Property prices were also screaming higher, thereby pushing more people to rent at the margin. When the Internet Bubble burst, the people who could no longer afford to own had to rent, thereby stabilizing rental prices from decreasing.
Cash is nothing more than a medium of exchange and stocks are pieces of nothing that lay claim to a company’s stream of profits. Buy real assets. 10 years later, you’ll be happy you did.
Readers, any of you own rental property? What are some of your successes and failures as a landlord? Discuss how you value rental property and where it lies in importance in your retirement portfolio.
Regards,
Sam – “Slicing Through Money’s Mysteries”
Financial Samurai (724)
krantcents (27)
retirebyforty (23)
JT (22)
Mike Hunt (20)
Money Infant (19)
Untemplater (18)
David M (17)
Janna (17)
shanendoah@The Do... (17)
A lot depends upon the location. I haven’t done this yet, but something that’s been on my mind recently.
Buying property in a prime spot may be expensive but relatively easy to rent. Is the premium worth it? That’s the key.
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Jon - Free Money Wisdom Reply:
June 25th, 2011 at 6:21 pm
I agree with you. I have been thinking about it lately too–but I think I am going to wait it out. I think the economy is going to get worse…not better — and that is when I will jump.
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As a landlord who is just breaking even, I still agree. It is extremely important to screen tenants, and you can get a credit check on them for about $10 (that will also check evictions and leins). Also, buy in a nice area!
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I agree 100%! We are renting out or old home and it is working out pretty well.
I’m searching for another rental property, but it’s tough to get positive cash flow. The property price is just too high on the West coast. If you can hang on for 5-10 years, it will be a lot easier to generate positive cash flow.
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As we all know, I have real property and Sam, I could kiss you for spelling out the real value of rental property. Everyone gets hung up on the value of the property appreciating, but unless you plan on selling the property, it really doesn’t matter what it is valued at if you don’t carry a mortgage.
I’m about 2.5 years out from breaking even and recouping all of my money from the property including the purchase price. The total break even time will be including the purchase price, insurance, maintenance, property tax, etc, will be a little under 4 years. After that, beyond what I estimate to be about 30% carrying costs, it’s all gravy! In order for me to get the money in interest for a home that I purchased for only $20K(!!!!!) but using my 401K as a piggy bank I would need to have roughly $315K in the bank earning 2% interest. My property is valued nowhere near that and I could care less because I can hold this property for the rest of my life.
Once I pay back the full amount I’m buying another one.
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Financial Samurai Reply:
June 23rd, 2011 at 2:55 pm
I welcome kisses, so thx! One just has to gut it out for the first 2-4 years, and after that, it really is like gravy.
It is a beautiful exercise to compare the rental yield to how much in cash you need to generate that rental yield. All about cash-flow!
Good luck with your new tenants!
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You are making me feel old(er) just talking about this. I owned at one time 34 units and a shopping center. Real estate is great because you can leverage it with a mortgage. It is also a business where you can increase your revenue over time. Having multiple units and locations allowed me opportunities to increase the rents. There is a natural turnover in apartments where vacancies are brought up to market rates. The value of a property is based on the underlying rents and the potential to increase rents. If you run your business profitably, your tenants are covering all your expenses and you have a profit. There is another aspect to income property which is depreciation. The buildings have a useful life and can be depreciated over time. That accounting device shelters your income earned from the property and can shelter outside income as well. I have been out of income property since 1991. It is a business not just an investment and should be treated as such. If you want some of the benefits without the headaches, consider REITS or partnerships, but they have risks too.
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smart money Reply:
July 13th, 2011 at 7:16 pm
Hope you’re not in oz because in the last 2-3 years, the REITS took a huge hit and are now priced below their face value. Some REITS are risky because they started developing instead of just buying properties that are already developed and earning a positive cash flow. Very few investment vehicles are headache free in this world.
Again, if you’re an Aussie, which I can’t tell from the what you’ve wrote, the property market has doubled about three times between 1991 and now. Properties that were $80k-$180k in 1991 are now $350k-$900k plus in 2011
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Financial Samurai Reply:
July 14th, 2011 at 8:53 am
Good thing I’m not in Aussie REITS! But, I sure wish I bought tons of Aussie property 10 years ago, especially with the AUD so strong!
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I wholeheartedly agree with the sentiments of the post as well as the comments. I have 6 SFHs and a half interest in a commercial building. I am breaking even overall when it comes to cash flow. The goal is to have it all paid off before retiring along with all other debts eliminated. That way, I can simply live off that income letting stock investments grow until forced to take distributions. I would like to purchase more but have kids getting to college age so am trying to manage my balance sheet a little better before going at it again.
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Financial Samurai Reply:
June 24th, 2011 at 1:17 am
That’s an impressive portfolio! Congrats man. Hope it is bringing you some great cash flow!
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Real estate is great as long as you can deal with systemic risk. It’s hard to minimize risk, and in many cases real estate investors incur higher risk, but with less risk-adjusted returns.
Much of the risk is, unfortunately, geographic. Look at Detroit. In it’s heyday it was a real estate dream. Property sold for reasonable prices due to its relative lack of “city sexiness” and midwest feel. Additionally, earnings for people without a specialization were strong, buoyed by manufacturing.
Then the manufacturing said, “see ya!” and the city went to garbage.
Obviously this is a rare case, but it does go to show how real estate is more than just basic finance in arbitraging the difference between cap rates and capital costs. Unfortunately, real estate doesn’t work so well with fixed-income models, either. Rents are rising tremendously, but home prices haven’t. Rates are falling, but home values aren’t rising.
At any rate, if you know the risks and feel comfortable, I think real estate is a great long-term vehicle for wealth generation. I wish there were a broad-based residential REIT, but unfortunately no one has made one yet. OPM doesn’t easily come into play with a REIT, but wealthy investors could potentially double up with margin at 2:1 with rates equal to Libor rates plus a point. Call money rates (currently 2 %) plus 50bp might be reasonable for $1M+ accounts.
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Financial Samurai Reply:
June 24th, 2011 at 1:17 am
Do you plan to start investing in physical real estate after you graduate JT?
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JT Reply:
June 24th, 2011 at 11:07 am
Considering I’d invest in pretty much anything, absolutely. That said, real estate is generally an investment that works its way into your personal balance sheet.
Examine two investments: Direct investment in real estate, or purchase of public securities.
In purchasing real estate with leverage (I don’t know why you wouldn’t, that is the allure, after all) you increase your personal debt-to-equity ratio, as well as debt-to-income.
In purchasing securities, you purchase part of a company, which may be just as leveraged to any business (real estate even) without putting it on your balance sheet. Just as an example, you could buy a company for..say $200 a share that has $1000 in assets and $900 in liabilities for every share.
Both direct real estate investments and public securities have the same leverage…effectively 5:1 with 20% down on a home, or 5:1 in assets-to-stock price with the public securities.
The difference, though, is one of opportunity. There isn’t a possibility that an individual could acquire the capital they need if their personal balance sheet is weighted heavily toward debt. However, another person (all things being equal) who owns securities could still access capital for future investment as their DTI and DTE are still reasonable on a personal level, even while maintaining similar leverage.
This is why direct investment in real estate doesn’t really excite me all that much. Wall street is a numbers game; I can make sense of it, with better accuracy and leverage. I can’t do the same with real estate–there are far more variables to secularize from a single individual property, or even 10 properties.
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smart money Reply:
July 13th, 2011 at 7:30 pm
Detroit is one city out of how many cities in the US? 55? That’s just using one extreme example. What if you used San Francisco like how the Samurai did? It would have been a different conclusion. Most property investors know that they need to diversify in terms of suburb location, cities and if you’re that successful, ultimately countries.
There will always be risks, it’s a matter of minimising the risks. It’s a shame that direct real estate doesn’t excite you because if done correctly, it really is one of the BEST investment asset that you can have in a diversified portfolio.
There’s nothing better than owning a positive cash flow property with rents that increases in line with inflation. You may understand Wall Street, but you will never beable to control Wall Street the way you can control a property that you own.
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JT Reply:
July 14th, 2011 at 11:02 am
One out of 55 is ~2%. If the chance of complete loss is 2%, then long-term RE yields have to exceed risk-free investments by 2% at a minimum. That doesn’t include the chance of partial loss, but whatever. It ignores structural differences too. Compounding with $5 shares is easy–not so much with $100-500k homes.
The mechanics of the US market are far different from the Australian market. You noted that rents keep pace with inflation, and that’s true, especially in the US, since 70% of the increase in US CPI is due to rising rents. The CPI calculus uses rents in the inflation stats, and then rents are used again to price increases in home values. Home values are dipping, but in the CPI calculus, home values are rising.
I don’t keep up with Australian economics all that much, but we’ll see how it all plays out. I’m sure investors are giddy with rising RE values in Australia but it’s short-sided. Australia is levered to emerging markets, particularly China, and has a massive influx of capital thanks to the risk-trade in AUD/JPY and even AUD/USD. Clearly, Australia is loving foreign hot money. Personal debts have almost doubled to 160% of disposable income since 2000. There’s a decade’s worth of cheap money in Australia. I’m sure plenty of it is due to real estate.
Different strokes for different folks. There’s more to RE than cash flow, supposed relationships between rents and inflation, and minimizing risks (though most RE investors don’t). There’s more to Wall Street than buying into a company you don’t control. Net-net, I think a lot of people have a natural tendency to dislike ownership of public companies and favor things that can be “controlled.” Wall St. is less risky than perceived, and real estate is more risky than perceived, in my opinion.
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smart money Reply:
July 14th, 2011 at 5:26 pm
Detroit is an outlier, an extreme and not a great representation of the general US property market. Detroit’s population has supposedly been declining since the 1950s from 2 million to around 713,000. Why would an investor acquire a property portfolio in a city that has a declining population and less and less jobs? The driver of the demand for property is the population growth and the development that is in the area. In 30 to 40 years time, will properties in New York/San Francisco/Toronto/London and any other major cities fall or be up? As population increases, the demand will increase and you will be lucky if you can buy that same house in New York at today’s prices in 30 years time.
Our economy is very different from the US. Mining and primary agriculture is unfortunately the dominant driver of our economy and because of that, yes we are reliant on China and the world’s appetite for buying the manufactured stuff that’s exported from China (US and Europe particularly and that’s why China has been buying all your US bonds and are now contemplating buying European bonds). And Australia isn’t loving foreign hot money in that way. Foreign money has been loving our Australian dollar because our risk free interest rates are the highest in the world and while it’s hot, investors get double bang for their bucks (currency gains + higher interest returns). The personal debt level of Australians do bother me and that is a great point you make because households here are very (and over)leveraged.
Au contraire, I am invested into both, real estate and stocks. They are equally the riskiest asset classes to own. Quality stocks such as Johnson and Johnson, Coca Cola, Apple etc are great when bought directly. Not mananged funds, mutual funds or hedge funds where they charge a high MER only to not provide any alpha returns. The problem with Wall Street isn’t the stock market per se but the financial machinations, derivatives and all the creative crap that comes out of Wall Street. All the ‘experts’ who invested billions into Madoff’s ponzi funds. All the ‘expert’ ratings that were crap coming from the ratings agencies who were paid to shut their mouth and give AAA ratings, all the AAA mortgage securities that were sold off to pension funds around the world which were infact, highly risky sub prime loans, all the companies who were trying to outperform for shareholders so they borrowed millions and couldn’t refinance during the credit crunch and thus collapsed. When you invest in public companies, you are highly reliant on the ratings, the ‘experts’ and the analysts who write ‘buy’ or ‘sell’ recommendations, the accounting firms which audit those companies and qualify their reports or move ‘short term liabilities’ to the ‘long term liabilities’ section to hide their upcoming refinancing… these are uncontrollable factors that are out of our control.
Thus, a mix of property, shares and risk free investments will always triumph over a portfolio that is just one or the other. Anyhoo, just my 2c
JT Reply:
July 15th, 2011 at 9:34 am
IDK, again, I think different strokes and different folks. You can discover accounting tricks and quarterly earnings manipulation just like you can find a leaky pipe under a house. You won’t find it if you don’t look. Blaming analysts is a lot like blaming a real estate agent for selling you the home. Australia loves hot money in the sense that private debt loads have grown quickest since the other developed world nations started ten years of easy money in 2000.
I know I can beat the market. I have. I also know that I can’t make real estate make sense for me. We’re not going to agree, though, because I really don’t care much for diversification in the sense that adding different types of investments I don’t like solely for diversification just doesn’t bode well with my investment thesis. Real estate might make sense when I’m 50, but in my 20s…meh. Besides, with so much “shadow inventory” in the US, buying real estate right now is like buying a stock right before it dilutes with new issuance. Too much to consider. If it isn’t simple, I don’t want it.
Regardless, the conversation is fun. I’ve enjoyed going back and forth with you because, at the end of the day, we both learn a lot from eachother, even if we disagree.
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smart money Reply:
July 18th, 2011 at 11:11 pm
I’ll have to agree with you on that one. That’s why all of us need to assess the level of risk that we’re comfortable with. After the financial crises and all the bad apples surfacing, I’ll always prefer to have a heavier weighting in direct property (plus the ability to leverage a lot more than in shares using OPM because our banks will accept a higher LVR for property than for shares).
Our markets are significantly different and if I were a US investor, I probably would stick to property in the major cities for fear of buying into a potential slum or not be enticed to buy one like youself. Right now, there have been heaps of property spruikers and new property funds(REITs) created so that Aussie investors can buy into the US property market- I can’t tell whether those funds will succeed or end in tears.
JT, whatever works for you – keep doing it. You’re right that we’re not going to agree because my mix of property + stocks works very well for me and I can’t imagine being able to sleep with having over a few hundred k’s in only one asset class. But you and I probably have different risk tolerance.
You might change your mind one day when you find yourself renting short term leases and constantly having to move your furniture around a few times (a/lease ended, b/rent spiked up, c/landlord won’t fix the problems, d/property got sold and owner wants to move in etc) … that’s what caused several friends and colleagues to contemplate buying :)
Anyway, I agree with you, it has been an interesting conversation and it’s been fun to discuss our different views.
I am with MC on this one…sounds cliche but it is about location. RE investment is not as good of an “investment” if the value of the underlying land does not appreciate. Structures deteriorate and will cost more to rebuild tomorrow than today and yesterday. Moreover, carrying costs which only creep up over time, and not necessarily under the creep up in rents either. RE is still a good “investment” for several reasons – cash flow, equity build up using OPM, tax benefits, leverage (I just took a LOC out at 2.5% and invested in a 9.5% instrument) and a prettier balance sheet. Whether one has to sacrifice the first few years into the deal is also location dependent. In jurisdictions where I invest, I generate positive cash flow from the time I buy the property. I can see however how/why one would be in a negative cash flow situation in places like California
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Sam, you make it sound so convincing :) I’ve never gotten into real-estate yet.
I think real-estate should be in my portfolio, but my only concern is time, which I’d rather use building my websites and writing my book – but perhaps that is me being disillusioned. Perhaps it wouldn’t take much time at all if I did it right.
How long have you been renting real-estate? What made you get started? What mistakes did you make at first (if any)? What would you recommend to get started, just looking for a good location and choosing a property?
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Financial Samurai Reply:
June 24th, 2011 at 1:15 am
Math is a beautiful thing. Can’t refute. Always do your conservative calculations and just start. Investing in yourself is great too. Consider doing what is most imoortant to you first. I’ve been renting out for about 8 years now.
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I’ve done some work in property management. It definitely helps to have a cool head because when something breaks it generally needs to be addressed and fixed very quickly (ex. plumbing problems, broken furnace, garage door problems, etc). Finding honest, responsible tenants makes such a difference too.
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I’m a fan of real estate but haven’t gotten in on it (except for my principal residence, in which we will rent the basement out). My dad on the other hand, is a mini-real estate mogul and I see him enjoying his passive income for an apartment building, a few houses, and a few commercial properties- he acts as the property manager too so he gets to keep even more of it to himself. I wish I bought 30 years ago LOL.
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Financial Samurai Reply:
June 26th, 2011 at 8:01 pm
Your dad is a smart man! Yes, I too wish I bought 30 years ago… but, that would mean I have 30 years left to live, so I’m fine with it!
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I agree, its a part of real estate investment. Income from house rental is a good supplemental income that can help a lot to survive an economic crisis. However, you are right, finding the right tenant is important to be able to be successful with this kind of venture.
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youngandthrifty sounds a lot like me, but I haven’t even gotten around to buying a house for myself. We’ve been moving so much that it just hasn’t seemed prudent to buy, rental or otherwise. Hopefully when I graduate and settle down in a new job I won’t have student loans, there will still be bargains out there, and will have the flexibility to take advantage of them!
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Financial Samurai Reply:
June 26th, 2011 at 8:01 pm
Pls don’t buy until you’ve got 30% of the house’s value in reserves saved up AND you know you will be there for at least 5 years, or hope to be! No rush!
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Sam,
I loved the post! As for me I own 7 rentals. I don’t actually have a primary residence (still too expensive to buy in LA). I just got into RE investing over the past 2 years and since prices (in the right markets) are so great, I’m seeing and ROI Cash on cash 25-30%. Each of the propertys have a positive cash flow of about $450-500 after debt service/taxes, etc.
Too many people look at real estate from the entire value of the asset vs the cash invested in the asset. I can definately see how one could get burned though. I would say if anyone is truly interested in RE investing (buy and hold), cash reserves are the key. That being said, if you buy right, you can also generate a nice passive income. I currently recieve 2800-3100 in side income from the rentals. I use a Property manager in the market i buy in. So far it has worked out great, but who knows. I think once I can bring in 7K, I may quit my primary job and take over the mgmt part of the business.
Its funny, all my friends are hung up on buying a primary home. Some of them have saved for as long as 5 years to put a 60-80K down payment (crazy i know) only to take on a 3K mortgage. On the other hand, I live essentially rent free (tenants cash flow pays it for me).
Anyway, I think the media and wall street has done a great job of scaring people from RE. However, if you get educated, RE investments can far outpreform stocks, bonds, CDs, etc.
just my two cents!
Arthur
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Financial Samurai Reply:
June 26th, 2011 at 8:04 pm
Wow, that’s a lot! Glad real estate will allow you to quit your day job and provide that steady income stream you need!
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Lee Reply:
December 31st, 2011 at 10:00 am
Where did you buy your property? I live in huntington beach, ca, and need some help.
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Great post! Now is the time to buy a place to rent – the market favors buyers and more and more people are choosing to rent. I had a friend back in college who decided to buy a condo. His reasoning was that the mortgage was less than rent payments, and thus he would save money. Of course, being young and inexperienced with real estate, he ended up losing money – at first. After graduating, he started renting the property to other students and is now starting to see a really great profit. I think owning a rental is not only a great financial investment, it’s also an excellent learning experience for investors of all ages.
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Financial Samurai Reply:
June 26th, 2011 at 8:06 pm
It definitely is a good learning experience, about an important asset class, the responsibilities of a landlord, running a business, and understanding taxes. Let’s just hope it’s not too expensive for too many folks!
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Why not just buy REITS in your porfolio. That would eliminate the risks and headaches of actually owning the property. Or am I missing something
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Financial Samurai Reply:
June 24th, 2011 at 3:58 pm
Leverage, control, returns, not directly owning a physical asset. I can write about this more later.
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Rental property is a great way to build significant wealth over the long term, but you can’t just jump into it without knowing what you’re doing. There are a lot of pitfalls and it’s not easy to get rid of a bad property once you have it.
One good rule of thumb I use to determine if a property will cash flow is the 1% rule. If the monthly gross rent is equal to 1% of the purchase price, you’re breaking even. If the monthly gross rent is equal to more than 1% of the purchase price, you’re starting to head into cash flowing territory.
This rule is by no means a substitute for full analysis when you’re making offers, but it will quickly help you determine if a listing you’re looking at on the MLS will potentially cash flow for you.
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I don’t own real estate yet, but some day I would like to!
I think I would try to get a triplex or larger. I don’t think I would own more than a few units though, but who knows with money comes opportunity…
So I have to settle for purchasing REITs like NLY (Annaly), at least until I have enough money to buy some actual real estate…
Just curious, do you manage your properties or do you just use a management company to take care of your rental properties?
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Financial Samurai Reply:
June 26th, 2011 at 8:08 pm
Don, frankly I wouldn’t do it if I were you. I’d rather just enjoy your liquidity, debt-freeness for the rest of your life!
I should write a follow up about investing in rentals before age 35 or something… b/c it requires work, and not something people in their 40s-70s want to deal with frankly!
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Money Reasons Reply:
June 27th, 2011 at 1:58 am
Actually, I was thinking of going in with my kids. Now granted, my son is only 10… I think he would do a good job in that role since he does well with people. Maybe when he’s 16 or 18.
I’m not sure about my daughter though, I don’t think she would do well in that role, she’s brilliant but get emotional easy, but then again she’s only 7.
Good point though, at that point in time that I’m considering I would definitely be in that age range that you mention. I probably wouldn’t like to be approaching 50 and deal with the hassle.
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I don’t think I could bring myself to take on as much debt as my earnings could allow me….. Just seems like a lot of stress and hassle and ultimately risk but of course I can see you are doing just fine so it’s likely a thing related to my mindset.
I have thought about renting out in the past when I was deciding if I should keep or sell my flat in London but i just couldn’t get the numbers to balance. The rent I could get was an easy $300 less than my mortgage at the time and other costs would have bankrupt me…. If you can buy a property out right or on a 50% or lower mortgage I can see how it could work out very well.
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Financial Samurai Reply:
June 26th, 2011 at 8:09 pm
Forest, with the way you like to travel and enjoy your life, I would think twice about getting into more debt too. Your London flat must be up a handsome sum. Just be happy with that!
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You’re so right. I’m itchin’ to do the rental property thing and just haven’t gotten my act together. Around here, the residential market is still priced to high to make sense (I’m not willing to buy a property that’s not cash-flow positive from day 1) and at some college campuses, I almost did a larger deal with a partner that fell through. Rents are spiking – because people aren’t buying homes! So, it’s naturally a great investment right now. Thanks for the motivation!
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Financial Samurai Reply:
June 26th, 2011 at 8:10 pm
Ironic isn’t it that rentals win either way, unless there’s a massive and permanent economic collapse! Always buy in the best place possible. If I can be cash flow positive in 2 full years, I’ll consider it if I see future appreciation.
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I am not a real estate owner yet, and still not sure whether it is the right thing for me to do.
I definitely see the benefits in owning real estate, but in my area, and in my life, there are still too many variables. Firstly, real estate in my city is overpriced compared to other areas. It continues with not having the time to look after my real estate, and perhaps my greatest barrier is a sense of wanting to be free… who knows where I want to be in 2 or 3 years from now.
Perhaps investing in real estate focused funds/securities is a good alternative.
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That only applies on a very liquid and developed market. Look at most of European countries, like Portugal, where I live. The housing sector is highly leveraged, therefore dependent on the euribor rate. With rates going up and record unemployment rates, npl’s will go up as well. On the other hand, rentals are nowhere near acceptable levels. With the IMF Mou, rents will decline, inflation will go up, housing values will go down. So, investing in a buy-to-let only based on yield, thinking that with inflation comes a house appreciation… think twice! That’s not entirely true, times are different now!
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I would like to invest in some rental property now, but I feel like I don’t know enough about the true costs of owning rental property, and I don’t have enough cash flow to cover contigencies, like large repairs or vacancies. Maybe in a couple of years.
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Financial Samurai Reply:
June 27th, 2011 at 2:32 pm
Don’t rush it for sure. Like having a kid!
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Sam, with interest rates low, and property values lowish, now is a great time to get into rental property. The one thing to underscore, which you stated very nicely, “there is no such thing as passive income.” If you get some bad tenants, have to make big time renovations, go vacant for a while, it is a a pain in the neck. Don’t get me started on “evictions.”
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MortgagesByMark Reply:
June 28th, 2011 at 9:21 am
If you manage the property yourself, it can definitely be a headache to deal with that stuff. My advice is to hire a property manager. Let them deal with the daily headaches and just figure the added expense into your numbers when you’re making offers.
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I loved having rental real estate as a grad student. I got excited every year with the “loss” on the tax return, yet having my mortgage covered.
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I’d like to get into real estate investments potentially in the next year. My goal is to purchase my first home and get a roommate that will help pay the mortgage then trade up after 2 years.
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Hi Sam,
What you’ve written is a fantastic post which articulates my thoughts on rental properties perfectly. The millionaires around us all have an extensive property portfolio (residential, commercial, interstate, overseas). I have a cf+ property and can’t wait to buy another one hopefully next year.
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I love our rental property and we are trying to buy another within the next year and half. It does take work but it can bring great profits and increase over time. When our tenant moves out in Sept, we plan to raise the rent since we have over the last year been fixing up the place. This should increase our income by 1.5%, not a lot but every bit helps.
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Financial Samurai Reply:
July 21st, 2011 at 7:49 am
Every little bit helps indeed, and you’ll wake up 10 years from now and be so happy you own your properties.
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