One of the greatest advantages to owning investment real estate is the potential for passive income that does not need to be earned. This is one of the many reasons that investors are attracted to rental properties.
However, the benefits of rental properties go much further than just the rental income. This article will focus on the other benefits associated with rental properties and a few rules that will help you get the most from having rental properties in your investment portfolio.
Rental properties can be a great investment vehicle for the following reasons:
Cash Flow – This is the primary reason that investors purchase rental or cash flow properties. The tenant makes a monthly lease payment that exceeds the expenses on the property. The remaining money is cash flow for the investor. Many investors accumulate rental units with the intention of using that income to pay their monthly expenses or to provide retirement income. When these rental properties provide them with enough monthly cash flow that they will no longer depend on having a job, they reach a point when their investments become their job.
Appreciation – Historically, properties have increased in value over time. So if you bought a $100,000 property and put $10,000 down as a down payment, you would have a $90,000 mortgage. Let’s say that after five years, the home is worth $150,000. You now have a $50,000 profit for your $10,000 investment. That is a 500% return on your investment over a five-year period and it does not even include the cash flow received during those five years. Even though appreciation rates in many parts of the country have been negative or flat over the last few years, appreciation has still increased over time. This is also not the primary reason why you would purchase a rental property. It is just a nice side benefit of owning rental properties.
Mortgage Reduction – This is where you get to use the power of other people’s money (OPM) in real estate. As your tenant makes monthly payments on the mortgage, the mortgage balance will decrease (assuming you have a fixed, amortized loan). As the mortgage balance decreases, you end up with more equity in the property, all at the expense of your tenant. It is a great thing to have someone else pay your bills. We know many investors whose retirement plan is to buy a couple of rental properties each year, let the tenants pay the mortgage until the loan is paid off, and then sell the home or use the income for retirement. The possibilities are endless.
Depreciation – Depreciation is an accounting term used to let people take a tax benefit for owning rental property. Depreciation is based on the idea that tenants cause “wear and tear” on the property. The depreciation is a way to reduce your taxable income at the end of the year. This will then provide you with more income because of the reduction in taxes you pay.
As you can see, there are a lot of good reasons to own rental property. Many people invest so that their money will grow, so it will provide income, or to take advantage of tax break opportunities. With rental properties, you get the best of all worlds because you can do all three (growth, income, and tax shelter) with the same investment. This is one example of why real estate is unmatched in its ability to provide wealth for investors.