Being Less Stupid #1 - Rental Property Investing
Is rental property investing right for you? What will be the passive income can we get from rental income?
Hello and welcome to the first edition of Being Less Stupid newsletter. My goal is to educate myself and my readers about a topic each week so that we can be less stupid on that particular topic.
In this edition, we will look into what Rental Property Investing is all about. Is rental property investing right for you? What goes into managing a rental property? How much passive income can we get from a rental property?
Click here to read the full article in my blog.
Rental Property Market
More U.S. households are headed by renters than at any point since at least 1965.
36.6% of households are renting their home.
The interest rate on the mortgage is near history low.
Pros & Cons of Owning a Rental Property
Pros
Cash Flow – The rent you receive will pay off your monthly mortgage, taxes, insurance, and expenses. You will be left with some cash as a return on your investment.
Property Value Appreciation – Your rental property will ideally appreciate in value over time.
Tax benefits – As a property owner, you are eligible for tax benefits. You can deduct depreciation costs, property management expenses, and insurance, among other expenses.
1031 Exchange – You can avoid paying capital gains taxes when you sell your investment property. You have to reinvest the proceeds from the sale within certain time limits in a property of equal or greater value.
Cons
Analyzing & closing the property – searching for properties, analyzing the neighborhood, negotiating with the seller, and closing the mortgage takes a lot of effort and time.
Down payment for a mortgage – You should be ready to pay at least 20% of the property value as a down payment to get a mortgage on an investment property.
Lack of Liquidity – Rental investment is not as liquid as stocks. You can not sell your property and get cash when you need it.
Rising Taxes and Insurance Premiums – Taxes and insurance premiums may increase in the future
Market decline – Housing markets could decline due to broader economic conditions. Also, the neighborhood you have invested in can lose its appeal which might depreciate the property value.
Dealing with Difficult Tenants – Tenant problems are your responsibility 24/7/365. Flooded apartment? Complaining neighbors? You’ll get the call.
Maintenance and Upkeep – Depending on the age of the property, you will have to fix or replace things to maintain the property in livable condition.
Calculating Return on Investment
Passive Income from Rental Savings
Equity Gain
Property Value Appreciation
Passive Income from Rental Savings
Passive income on a rental property is what’s left after all the expenses are paid. They call it the cash on cash return on investment.
To calculate the cash on cash on ROI we need to calculate the total investment, income, expenses, cash flow. Below is a snapshot of the spreadsheet I put together to calculate the cash on cash ROI.
Equity Gain
Over time the principal you pay off of your mortgage accumulates as your equity. In the example we looked into, Marshal will accumulate around $12,000 at the end of 5 years. In 10 years he would have accumulated $26,000.
Property value appreciation
Some people buy properties based only on the expectation of property value appreciation. Property value appreciation depends on the location you invest in. Property value will rise faster in metros than in smaller cities.
Together with passive income, equity gain, and property value appreciation, rental property investment seems to be a good investment option. Remember, you can also deduct the depreciation costs, property management expenses, and insurance, among other expenses from your tax returns.
Until next week
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