Renting as an Investment Strategy

We discussed using rentals as a way of getting out of a changing market when you find yourself upside down. Much more pleasant is renting because that is your strategy. You want to build up a portfolio of properties so that you can retire on the income from the rents. Even better is if you have enough that you can hire a property manager so you don’t have to worry about the issues.

Cash flow

Renting has several benefits that investors know about but most people don’t think of. You only want to invest if you can get a positive cash flow each month. So the first benefit is positive cash flow. Another benefit occurs because of that. It means that your renters are paying your mortgage and insurance and taxes for you. Even better, rents typically go up over time but the monthly mortgage payment does not (unless you have a variable rate mortgage, then it might). That means your cash flow will increase with time. And when the renters have paid off the mortgage for you and the house if free and clear, the cash flow will really jump.

Capital Gains

 

And finally, there is capital gains. Typically real estate increases in value over time (assuming it is maintained properly). Yes, sometimes it dips in value like it did in the 2007-8 time frame. But over the longer term, it has always steadily increased. That means that besides the cash flow, you will be getting an increase in the value of you asset, i.e. capital gains.

Leverage

What is most impressive is the leverage. Typically you put 10-20% down on a house. Let’s use $100,000 as the value of the house because it makes the calculations easy. You put down $10,000 and get a mortgage for the rest. If you assume an increase in value of 3% a year, it won’t take that long for the value to go up 10%. Not bad, right?

Wrong, it is phenomenal. Why? Because you put in $10,000 and the value of the house has gone up 10% or $10,000 which is a 100 percent return on your money and that is not including the cash flow and the tax write-offs from depreciation etc.

Compare this with investing in stocks. If it goes up 10%, you money has increased 10%. If you invest in speculative stocks that can go up 10 times or more, the key word is speculative. You might also lose your money. You can also lose money in real estate, but you still have the underlying value of the property. So you have a leveraged upside but not a leveraged downside. Pretty nice.

Renting as an Upside Down Solution

There are several situations where you might want to rent. Hopefully you will never need to use one of them.

Upside Down

We will get the bad one out of the way first, but it can be a lifesaver if you need it.  In 2007 and 2008 when the market turned down fairly quickly it caught a lot of people flat footed. Rehabbers who had bought places to fix up and sell found that by the time they had finished the rehab, the value of the house was close to the mortgages on it or even less than the mortgages. If they wanted to sell it, they were going to have to come up with money out of their own pocket. In other words, they were going to lose money on the project.

So, one solution to this is to take the hit and move on before the value decreases further. The other is to wait it out by renting it. The one problem is that by the time the market comes back, renters will have done enough wear and tear that you will need to do at least a minor rehab again.

One thing you need to figure out is what are the rents in the area and will you be in a positive cash flow situation. If you borrowed from a hard money lender at a high interest rate, this might not be a good option. You will be losing money each month. And the problem there is that if the value of the house has gone down because of the market going down you won’t be able to refinance it with a bank at a reasonable rate to make it cash flow. You are kind of stuck.

Depending on where the property is located, you may want to investigate Section 8 which will be discussed in more detail in another entry.