Lex Levinrad lists the benefits of holding rental properties, especially in the long term.
Lex reminds us that rent can be steadily risen as appreciation occurs, there’s depreciation regarding taxes, among other benefits you have when holding rental properties long term.
Announcer: Welcome back to the FlipNerd.com REI Classroom, where experts from across the real estate investment industry teach you quick lessons to take you business to the next level. And now let’s meet today’s expert host.
Lex: Hi everyone. This is Lex Levinrad with the Distressed Real Estate Institute. We got another lesson here for REI Classroom, and this one is about the long term benefits of investing in income properties.
Announcer: This REI Classroom real estate lesson is sponsored by virtualstaffnow.com.
Lex: Okay, so if you’re thinking about investing in real estate, especially if you are a new investor and you’ve never purchased a rental property before. Or even if you’re an existing investor, maybe you have a rental property and you’re feeling a little discouraged, what I’d like to do is break down five key important points for you to consider when looking at rental properties. And I’m going to show you why focusing on the long term is much more important than focusing on the present. Okay?
So the first thing is you buy real estate for appreciation. Now, you might have periods of time where real estate goes down in value like we had from 2008 to 2007 to 2010, let’s say. We had a period like that back in ’89 to ’94 as well. But if you look at over the long haul, just take as an example the US Housing Authority’s median price of a single family home going all the way back to 1964. You can get that online. You’ll see how much real estate has appreciated over the long haul.
So any 10, 15-year increment, real estate has gone up. So appreciation is obviously one huge benefit. But that’s a stated benefit and everyone’s aware of that. What a lot of people don’t realize is the other benefits that you get. Let’s go through those real quick.
First of all, depreciation. Current IRS regulations allow you to depreciate a single family home over 27 years. So what that means is that if you have a $100,000 house, every year it’s worth 27% of $100,000 less as far as the IRS is concerned. Now that doesn’t make any sense but that’s what they do. They allow you to depreciate it because it’s an asset. So that depreciation is an actual expense which is a tax deduction and offsets your income, okay? That’s the first benefit, depreciation, and over the years if you hold a rental property for 10, 15 years, that depreciation expense can be substantial – tens of thousands of dollars.
Another item that you have other than appreciation is amortization. Okay, so let’s say you have a mortgage payment and your mortgage payment’s $1,000 a month. Let’s say your rental income is also $1,000 a month. When you look at it on the surface, you might think you’re not making any money and you’re right. Your cash flows break even. However, as far as your tax return is concerned, you’d actually have tax benefits because the depreciation expense would show up. It would show that you’re losing money even though you’re not. But the big kicker is the amortization, meaning on that $1,000 a month mortgage payment, it could be $900 of interest and $100 towards principle, which means every month you’re basically reducing your principle balance that you owe by $100. So it’s almost like a forced saving plan where you’re being forced to save $100 every month.
As the mortgage matures and goes closer to its expiration, let’s say it’s a 15-year mortgage, by the time you get to your five or your six, you have substantially more than 100. You might have $300 or $400 being paid toward principle so now every month it’s a forced saving plan. So the amortization can also be a substantial benefit, right?
So we’ve covered so far appreciation, depreciation, amortization, and we’ve covered the tax deductions. Other items like property taxes, insurance, oil repairs, maintenance, anything that you have to do to fix the house, well, that’s deductible too, right?
So the final thing is cash flow. Now, cash flow using our previous example of $1,000 a month rent and $1,000 a month mortgage payments, you might think, well, you have a break even cash flow, but you can typically increase rents at 3% to 5% in most markets, and some markets they’re going up a lot higher. I have rental properties with leases at $925 a month that one year later I’m increasing the rent to $1,150 or $1,200, substantially north of 5%.
But even using 5% as a rule of thumb, on a 5% increase $1,000 a month next year will be $1,050. The following year will be $1,100. The following year will be $1,150. The following year will be $1,200. So even if today it might have been break even cash flow, within two years it could be making $200 a month.
If you fast forward over the years, by the time you get to, let’s say, year 10, well, just fast forward those numbers. You could see you could be easily at $1,600 a month and now your mortgage payment is $1,000 a month so now every month you’ve got the $600 of positive cash flow coming in. So if you take the positive cash flow benefit plus the tax deductions plus the depreciation expense plus the forced savings plan with amortization, you can see how even with a rental property that appears to be break even cash flow, it can have substantial benefits for you.
The problem with most landlords is they don’t think long term. All they think is, “I have another repair. I have to pay for it. I’m not making any money,” and many landlords quit. But if you can just sit in there for the long term, you will see the long term benefits of owning income properties.
Okay, so once again this is Lex Levinrad with the Distressed Real Estate Institute and I want to see you guys out there. I always say to people if you rent, figure out a way to buy your home. And if you already own your own home, figure out a way to buy just one rental.
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