A vital ingredient to a strategically optimized portfolio
The Pre-Investment Phase
As long as you’re smart about the properties you invest in, you should be able to effectively “self-finance.” In other words, the rent payment you receive should cover all of your expenses (and then some). And as the loan is amortized over time, an even larger percentage of each monthly rent check goes toward paying down the principle on the property.
Owning an investment property is like having a monthly cash distribution. Just open up your bank account each month and the rent check is safely deposited.
While it’s the ongoing cash flow that most investors are after, don’t underestimate the long-term appreciation. Real estate values almost always increase over any five- or 10-year period. (Sometimes quite substantially.) Not only does this increase your borrowing power (via a HELOC), but it also gives you a nice bump in equity when you choose to sell.
Single family rentals are some of the most tax-advantaged investments you can own. Not only are operating expenses deductible, but so is mortgage interest and depreciation. And depending on how you set up your investments, you can qualify for pass-through deductions as well.
Typically, you have to pay capital gains taxes when you sell an investment or other asset. But with real estate, you benefit from an IRS code known as the 1031 Exchange. This allows you to take the proceeds from the sale of one investment property and invest it into another similar property and defer tax payments. This basically lets you kick the can down the road, paving the way for rather substantial wealth creation.
Most investments decline in value during a recession. Rental real estate? Not so much. The demand for rental properties actually increases during times of economic uncertainty. That’s because fewer people buy homes. And as interest rates rise, a large chunk of middle class America gets priced out of the market.
Inflation says that the same products will be more expensive in the future than they are today. It’s why a loaf of bread used to cost $0.10 or $0.12 in 1950, yet costs $3 to $4 today. It’s not that people like bread more today than they did 70 years ago. And it’s not that the ingredients or recipes have changed dramatically. It’s simply a result of economic inflation. Unfortunately, consumers take the brunt force of most inflation. But by purchasing real estate – which typically increases in value faster than inflation – you can hedge your portfolio.
The Cash-In Phase
“Real estate cannot be lost or stolen, nor can it be carried away. Purchased with common sense, paid for in full, and managed with reasonable care, it is about the safest investment in the world.”
– Franklin D. Roosevelt, U.S. president
“Ninety percent of all millionaires become so through owning real estate. More money has been made in real estate than in all industrial investments combined. The wise young man or wage earner of today invests his money in real estate.”
– Andrew Carnegie, billionaire industrialist
$30,000
$30,000
$120,000
$9,101
$758
$30,000
$4,800
$34,800
INCOME ANALYSIS | YEAR 1 | YEAR 2 | YEAR 3 | YEAR 4 | YEAR 5 | YEAR 10 | YEAR 20 | YEAR 30 |
---|---|---|---|---|---|---|---|---|
Gross Scheduled Income | ||||||||
Less Vacancy Allowance | ||||||||
Gross Operating Income | ||||||||
Property Taxes | ||||||||
Insurance | ||||||||
Utilities | ||||||||
Homeowners Association | ||||||||
Maintenance Reserve | ||||||||
Property Management | ||||||||
Total Operating Expenses | ||||||||
Net Operating Income | ||||||||
Capitalization (Cap) Rate (%) | ||||||||
Less Mortgage Expense | ||||||||
CASH FLOW | ||||||||
Cash on Cash Return | 4.8% | 6.1% | 7.5% | 8.9% | 10.4% | 18.7% | 41.4% | 75.3% |
EQUITY ANALYSIS | YEAR 1 | YEAR 2 | YEAR 3 | YEAR 4 | YEAR 5 | YEAR 10 | YEAR 20 | YEAR 30 |
Property Value | $150,000 | $156,000 | $162,240 | $168,730 | $175,479 | $213,497 | $316,027 | $467,798 |
Plus Appreciation | $6,000 | $6,240 | $6,490 | $6,750 | $7,020 | $8,540 | $12,642 | $18,712 |
Less Mortgage Balance | $118,659 | $117,228 | $115,701 | $114,071 | $112,333 | $101,731 | $66,798 | $0 |
TOTAL EQUITY | $37,341 | $45,012 | $53,029 | $61,409 | $70,166 | $120,306 | $261,871 | $486,510 |
Total Equity (%) | 24% | 28% | 31% | 35% | 38% | 54% | 80% | 100% |
FINANCIAL PERFORMANCE | YEAR 1 | YEAR 2 | YEAR 3 | YEAR 4 | YEAR 5 | YEAR 10 | YEAR 20 | YEAR 30 |
---|---|---|---|---|---|---|---|---|
Cumulative Net Cash Flow | $1,686 | $3,823 | $6,432 | $9,531 | $13,143 | $19,651 | $34,042 | $60,237 |
Cumulative Appreciation | $6,000 | $12,240 | $18,730 | $25,480 | $32,500 | $41,040 | $53,682 | $72,394 |
Total Net Profit if Sold | - | $1,309 | $9,548 | $18,158 | $27,158 | $78,674 | $224,020 | $454,393 |
Annualized Return (IRR) | - | 10.9% | 15.7% | 17.6% | 18.4% | 18.6% | 17.5% | 16.9% |