J Money recently sold a web property and is toying with the idea of using the proceeds from that sale to buy a real investment property.
Bottom line up front: This is a great idea.
My experience with owning an investment property has been great so far. Very smooth.
I, like J Money, had heard that investing in real estate was a very good way to increase income and accumulate wealth. A couple of years ago we moved up to a larger house, and rather than sell our old house, we kept it as a rental. The main advantage of getting into real estate this way was that we knew very, very well what the property was like, since we had lived there for eight years.
The one thing that helped immensely was having a property manager. Having someone with experience in getting tenants and managing them took a big load off of my shoulders psychologically. I despise conflict, and there is definitely the chance of getting into conflict with tenants. (We didn’t have any problems with our first tenants, by the way.) Having someone in the middle staves off the possibility of getting into a disadvantageous relationship with destructive tenants, tenants who don’t pay, etc., because I would probably “go soft” and let them stay even if they didn’t pay. It’s hard to make money if the tenants are living in your house for free.
I’ll address some of the topics J Money brought up in his post (have a read!):
- The cash flow generally gets better as time goes by. Two reasons: inflation, and lowered expenses when the mortgage is paid off. If the mortgage on the property is a fixed-rate mortgage – a very good idea! — then the monthly out-of-pocket payment won’t change, but market rates for rents will creep up due to inflation. Secondly, when the mortgage is paid off entirely, that expense goes away. This is usually at least several hundred dollars per month, or upwards of $1,000 a month. Then the cash flow really gets fun!
- There is maintenance. No question about that. Trees get blown over, appliances go, doors need to be repainted, etc. These are all deductible expenses, so that’s the good news.
- Driving by property you own is cool. I won’t deny that! Well … we don’t quite own it, because the bank has a claim on it now, but the idea of providing housing for someone else is great.
- Diversifying is an excellent idea. Web properties are great. Stocks are great. Precious metals are great. Cash is great. And income-producing rental properties are great. Having some of all of the above? That’s really great. Nothing performs well all the time. In light of the past few years, real estate is obviously no exception. But having a stake in several kinds of assets reduces the chance that a downturn will completely wipe you out.
- Dealing with an investment property is a good skill set to have. I think that people who are already successfully self-employed (like J Money) have an advantage here, since a fair bit of working for one’s self also applies to managing an investment property. The management can be more hands-off (at higher expense) or very hands-on; the degree of involvement is up to the investor. I’ve done almost none of the maintenance on my investment property, but instead I’ve paid people who are better at it than I am to do it. I do handle the financial part: the reporting, the payments, etc.
- Money is incredibly cheap now. There’s no doubt about that. Mortgage rates are in the floor now. If your credit is stellar and you have the money for a 20% down payment, borrowing through conventional means for an investment property is extremely affordable. Whether prices have further down to go, I don’t know, but they are lower than they were a few years ago. The key to gauging affordability of rental properties is to do research. Check houses out. See what rents are being asked, for what size houses, and where. Calculate mortgage payments based on sales prices. It’s all numbers.
- Most expenses can be written off, but some not immediately. The appliances I bought for the rental need to be depreciated over three to five years. But mortgage interest, insurance, management fees, mileage to/from the property for rental management activities, and so forth are all deductible. The house itself can be depreciated to the tune of a few percent of its value per year. This decreases the basis in the property, and is recaptured upon sale, but this just helps the cash flow while it’s in service.
- Someone is paying your mortgage! Yes! A thousand times yes! The first couple of years with our rental, we were just about breaking even on the cash flow. But that is completely all right, because although I wasn’t getting cash thrown off of that property, my mortgage balance went down, each and every month. It’s the hidden silver lining to a slightly cash-negative property. Call it a forced savings account in that case. On the upside, once one mortgage is completely paid off, it becomes much easier. The cash flow above and beyond can be used to pay down another rental property faster. Also, the property itself can be borrowed against to purchase more property. Just like Monopoly® baby!
So, call me a fan of real estate investment.