I’ve mentioned in previous articles that I’m an advocate of real estate investing (REI) and that I own a rental property, but I haven’t gone into much more detail than that. While I’m not inclined or smart enough or a good enough writer or am able to spell enough werds to provide a comprehensive overview of the benefits of REI, I will tell you why it’s the right investment for me. And while I think real estate in general is the shit, the type of REI that best fits my lifestyle is single family rental properties, so that’s what this article will focus on.
Which Real Estate is best?
I don’t think any one kind of REI is better than any other – I can’t stress this point enough. I chose to start my REI portfolio with a single family rental property simply because its the right investment for me: a simple man in his 20s who didn’t want to quit his job or fall into extreme debt, and wasn’t afraid of some good old-fashioned hard work but still prefers investments that provide passive revenue streams. If you share any of those same qualities or desires, maybe rental properties are for you too! If you don’t, you probably have a social life – good for you.
But in all seriousness, if you’re looking to make a career out of real estate, this article is not for you. There are incredible sites (I highly recommend the BiggerPockets community) out there whose core focus is educating individuals on the theory, strategy, and practice of REI. I don’t want (or am able) to go in that direction. This is a lifestyle design blog, not a real estate tax code blog.
Rental Properties are neat. Here’s proof.
Let’s start off easy-breezy before we get into some of the denser, more technical benefits of investing in rental properties.
1. I already knew how the game was played
I’ve been fortunate enough to have always had a roof over my head. For the first 18 years of my life, I lived under the roof that my parents owned. I understood that they borrowed some money to pay for it upfront and were paying that money back every month.
When I got out of that hell hole, I moved under a new roof where the owner wasn’t as generous as my parents – this asshole asked me to pay rent every month. It wasn’t complicated to figure out how this worked. The asshole bought the property, and instead of living in it himself, he let someone else live there for a monthly rate.
I’m sure most of you can relate fairly well to my living arrangements. And that’s the beauty of investing in rental properties – most of us have been playing the game for years, and by investing, we’re just changing teams!
The oft-compared investment alternative to real estate is stocks, which unless you have built, run, and taken a business public, is a much more foreign concept. While I’m typically in favor of stepping out of your comfort zone and trying new things, in this case, I’m more than happy to stick with what I know.
2. I like to be in control – especially when it comes to my moolah
While my rental property is far and away my largest investment in terms of both money and time, my portfolio also includes an employer-sponsored 401K and an IRA.
When I was doing my taxes last year I realized that I could hide some money from Uncle Sam if I contributed to an IRA. So I did. Because I wasn’t regularly contributing to the IRA, it was easy to track how the performance of the market affected my investment.
Let’s say my initial (and total) investment was $1000. At first the market was on a tear, and my money grew to $1100. It plateaued for a while before slowly returning to $1000. Then it tanked to $900. Then it recovered to get back close to where it started. Currently, the market is struggling and the value of my investment is at an all-time low of $850.
Because I don’t plan on withdrawing funds from the IRA for 35 years, I’m really indifferent to how the market performs today. But what fascinates me is how my money grows and shrinks and it’s completely out of my control. And so goes investing in stocks. You can trick yourself into thinking you can beat the market (you can’t, unless your name is Warren Buffet, in which case I’d like to say that I’m flattered, Mr. Buffet), but after you choose which company or fund you want to purchase, your hands are tied. Aside from the occasional re-balancing of funds, you are utterly useless to your investment.
That’s just not the case with rental properties! The owner of the property plays an active role in its performance. That is to say that, House X can make a great investment for Owner A, but a lousy one for Owner B if Owner B doesn’t know how to manage it. The following are some of the ways one can directly add value to a rental property:
- Full-blown renovations or remodeling
- Cosmetic improvements (painting, replacing kitchen counters, fixing the garage door, landscaping)
- Charging the proper amount for rent
- Marketing to reduce vacancy
- Choosing proper tenants
- Managing tenants effectively
- Minimizing costs by having good contractors or the skills to maintain the property yourself
There’s not a universal way to evaluate the performance of a rental property, but some of the commonly used metrics are cash-flow, return on investment, and capitalization rate. The fact that I have the ability to influence these metrics (within reason) is one of the primary reasons rental properties are my investment of choice.
3. Living in a structure with roofs and walls and plumbing and electricity is not going out of style.
In 2015, Facebook, Apple, and Netflix were sexy companies to buy stock in. Ten years ago, these companies did not exist, were not public, or were not overly appealing to consumers. The stock market is defined by current trends, and predicting what the next trend is going to be is difficult. The same cannot be said for the real estate market. While it too is defined by trends, the same trend has manifested itself over the last 200+ years: people like having shelter and are willing to pay for it.
“What about the housing market collapse in 2008?”
Sorry, tough guy, that wasn’t caused by people no longer wanting to live in or pay for a home – quite the opposite actually: people overvalued what a piece of property should cost which resulted in them being upside down in the investment (owing more money to a lender than the investment is actually worth).
For me, the crash serves as a reminder as to just how stable investing in rental properties can be if done thoughtfully. Put down your pitchforks and consider this for a second. The crash resulted in home prices dropping 33%. Rent dropped 0-5%. The largest price drop in the history of American housing resulted in rents decreasing by 5%. Sign me up for a slice of that invincible investment*!
While the economy has pretty much recovered from the recession now, I want to explore the effect it had on young people. Even as unemployment reached new post-depression highs, the number of people attending college and the cost of college kept increasing. So, we’ve got all these millennials up to their ears in college-loan debt with a slim chance of finding work after graduating. Combine that with the fact that they’re (this next word is an adjective not a verb) fucking millennials – they have no interest in staying in once place for long.
All I’m hearing is that there’s a generation who finally has enough money to move out of their parents’ house, but doesn’t want to be tied down anywhere for long. You rent, bro?
Rental properties are neat. Even according to nerds.
The three reasons mentioned above are more or less my personal reason for digging rental properties. There are much more established and frankly better reasons for why REI is dope, and we’ll fly through those now.
1. Rental properties produce monthly cash flow
Cash flow is the reason why anybody gets into rental properties. Cash flow is the money you make from collecting rent everything month… if only life were that easy. You’re going to have expenses that eat away at your cash flow including: mortgage payment, property taxes, insurance, maintenance, capital expenditure, vacancies, etc. If you’re a renter and think that your landlord is pocketing the entire rent check you write her every month, you’re a fucking idiot wrong. The goal is to have a positive cash flow of a couple hundred bucks at the end of each month depending on your investing strategy. This is what keeps your investment invincible*.
2. There are really attractive tax benefits associated with rental properties
To reference the concept made popular by Robert Kiyosaki in Rich Dad Poor Dad – when you work for an employer, you earn a salary/wage, that salary/wage gets taxed, then you get to take the rest home and spend it on god knows what. With real estate, you generate some revenue, you spend it god knows what (those expenses mentioned in the cash flow section), and then you get taxed. Taxes after expenses! This is huge!
On top of that, the government recognizes that your house is a physical structure and like all physical structures it suffers from wear and tear and thus deteriorates over time. The government calls this depreciation and it means a nice tax deduction for the homeowner.
On top of that, when you borrow money to purchase a property, the lender is going to make you pay interest on the money you borrowed (called principal). Interest sucks. But guess what – it’s also tax deductible! This doesn’t suck.
3. Leveraging your investment can produce nasty returns
The power of leverage is best explained by a competent teacher. Or with an example.
If you wanted to buy $100,000 worth of stock, you would have to put down $100,000 in cash. If the stock increased in value by $7,000 after a year, you would have gotten a 7% ($7,000/$100,000) return on your investment. Not bad.
Now, if you wanted to buy a house valued at $100,000, it’s very common to get a loan to covers 80% of the purchase price, so you only have to come up with $20,000 yourself. Just like the stock, let’s say the house is worth $107,000 after a year. Here, you achieved a 35% ($7,000/$10,000) return. Mah man.
The cherry on top of the icing on the cake which was also soaked in rum (the cherry not the cake).
You don’t buy a rental property with the expectation that it is going to increase in value. This is called appreciation and banking on it is for speculators (read: chumps). People who buy rental properties are not speculators – we’re investors.
With that said, just like the total stock market, the real estate market has this 100+ history of growth. Sure there were some hiccups during that period (The Great Depression and Recession), but those are exceptions to the trend, they don’t define it. So, there is a pretty good chance that if you buy a piece of property with a decent amount of a thought and common sense, it will be worth more when you go to sell it in the future. But you never, ever, ever, ever rely on it. It’s an added bonus; just like that rum-soaked cherry. What?
Rental property investing for the common man
There you have it – a combination of why I’m a fanboy of rental properties and why people who make a living off of them are into them.
*Rental properties are absolutely not invincible. If they were, everyone would invest in them, and everybody doesn’t. However, most people misunderstand the risk associated with this type of investment. The risk isn’t that the housing market is going to crash overnight and your home is going to lose 50% of its value. You don’t care about that. You’re not interested in selling so you pay no attention to what its current value. The risk with rental properties is negative cash flow (expenses being greater than rent). While there are steps you can take to damn near ensure that this doesn’t happen, you can’t fully protect your investment against everything (tenants that are the spawn of Satan, unexpected damages that aren’t covered by insurance, that sort of thing).