My father has said on more than one occasion “It’s not how much money you make; it’s what you do with the money you make that will give you financial freedom.” My friend, and real estate colleague Larry Kendall, refers to this concept as “having Wake-Up Money”–waking up every morning and having the money you need to fulfill your dreams.
Let’s talk about investing in single family homes as rental investment properties. Investing in real estate is not for everybody; 1) it may take a larger equity investment than you are comfortable with, 2) it is not a “liquid” investment like a stock portfolio, in that when you decide to sell – you can’t have your money the next day, and 3) you may have to feed it in lean times. So if I haven’t scared you away yet, let me share with you all of the reasons you should invest in residential rental properties.
Investing in rental properties can give investors a great hedge against inflation, and greater returns than other types of investments. If bought right, financed right, and managed right, returns can appreciate 10% – 15% on an annual basis. Your investment return can come from any combination of four (4) potential sources: the annual cash flow from the property (net income), the principle reduction (reducing your mortgage with rent payments), depreciation (legal expense deductions provided by tax laws) and appreciation (how much your property increases in value). Another good reason is that you can see it, touch it and manage it yourself (if you wish). Lastly, since everyone needs to live somewhere and not everyone will choose to buy for themselves, rental property will continue to be a desired commodity.
So why invest in Mesa County? While many sophisticated investors buy rental homes all around the country, there’s more comfort for most investors in knowing the investment is local and being able to drive by it every day if they wish. Typically you know the market you live in, and feel more in control of a local investment rather than being an absentee owner. Relatively speaking, our rental rates in the Grand Valley have remained strong and vacancy rates are dropping. Lastly, even though we have all felt the effects of the recession, Mesa County is well positioned going forward as a great place to work and live.
Probably the most frequently asked question is “Why Now”? What makes this the right time? Simply put, in my 38 years in the business I have never seen a better time to invest in rental properties. I have experienced low home prices and low interest rates; but never at the same time. Home prices have been at their lowest levels in four to five years, and we are now starting to see median prices edging up which points to a recovery in our housing market.
Now let’s talk about the pros and cons of borrowing money to buy rental properties. Simple example; if you paid cash for a $100,000 investment property and have a net income of $7,000.00 per year, that is a 7% return on your equity investment (cash on cash). Now if you borrowed $50,000 at 6% and put $50,000 of your own money (equity) in, your return would be 8%; if you borrowed 75% at 6%, your return would be 10% ; and if you could borrow 90% at the same rate, your return would be a whopping 16%. So why not borrow as much as possible to get that higher return?
My economics professor in college always reminded us that “reward and risk are commensurate” meaning the higher the reward (return) the higher the risk. That’s why savings deposits (insured by the Federal Government) offer a lower return than a well-placed stock portfolio or real estate investment. Leveraging (borrowing) your investment in real estate certainly does influence the return, but the risk can be greater if the market softens and you find your rental income less than your mortgage payment. My counsel would be to stay in the 60% to 75% range of loan to purchase price. It’s wise to give up a little return to minimize the risk. And it would be wise to put aside at least 3 months of rental expenses for the lean times. So if it costs you $1,500 per month for your mortgage, taxes, insurance and utilities; always have at least $4,500 set aside to cover you through lean times. People can get into trouble with rental properties if they borrow too much or don’t have enough money set aside.
So when is it the right time to sell? Simply put it’s when you begin to see the returns (cash on cash) diminish. Many get caught up in increasing values (betting on the come) and ignore the current return. Most smart investors try to be out of the market before values (prices) peak, and get back in the market just before prices hit bottom. This is easier said than done, but it’s best to keep your focus on your cash on cash return.
So while investing in rental properties is not a slam dunk process, and not one everyone should participate in, there is definitely some upside and the current marketplace is ripe for the savvy investor to get in and stake a claim. One last parting thing to consider, even though many investors are very capable of managing their own properties; hiring a professional manager can enhance your income stream, save on operational costs, and give you peace of mind.