Tag: cash flow

  • Why do You Really Want to Own Rental Properties?

    Why do You Really Want to Own Rental Properties?

    Before you start doing something, figure out why you’re doing it.

    Someone smart probably said that at some point, right?

    We’ve spent a lot of time recently talking about the main reasons why I invest in rental properties. We’ve also talked about the work involved with owning rental properties.

    I’m a big believer in the power of real estate. I’ve also come to appreciate just how much work is involved in owning rental properties.

    The reason I’ve spent so much time writing about the benefits and the work involved is to make sure you know exactly what you’re getting yourself into.

    Once you fully understand and appreciate the benefits and the work involved, you’re ready for the next step:

    Think and talk about why you want to own rental properties.

    Depending on why you want to own rental properties, your strategy may be different than mine or someone else’s strategy.

    The key is to figure out your “Why” before making costly mistakes, in terms of both money and time, that don’t help advance your goals.

    Don’t skip this crucial step and jump right to analyzing deals.

    The last thing you want to do is take on such a big commitment without truly knowing why you’re doing it.

    To help you start thinking about a strategy, let’s review the benefits and also the work involved in owning rental properties.

    You can read much more in my series on real estate here.

    1. Rental property cash flow is king.

    With cash flow, you can cover your immediate life expenses. For anybody hoping to reach financial freedom, it is essential to have income to pay for your present day life expenses. 

    For my money, cash flow from rental properties is the best way to pay for those immediate expenses.

    If your present day expenses are already covered, you can use your cash flow to fund additional investments. 

    That might mean buying another rental property or investing in another asset class, like stocks.

    2. Long-term wealth through appreciation.

    Appreciation simply refers to the gradual increase in a property’s value over time. 

    While cash flow can provide for my immediate expenses, appreciation is all about the long-term benefits.

    Like investing in stocks over the long run, real estate tends to go up in value. The key is to hold a property long enough to benefit from that appreciation.

    To benefit from appreciation, all I really need to do is make my monthly mortgage payments, keep my property in decent condition, and let the market do the rest.

    Blue and orange apartment symbolizing that you need to know your strategy before buying rental property
    Photo by Brandon Griggs on Unsplash

    3. With rental properties, other people pay off my debt.

    When I buy a rental property, I take out a mortgage and agree to pay the bank each month until that mortgage is paid off. At all times, I remain responsible for paying back that debt.

    However, I do not pay that debt back with my own money. 

    Instead, I rent out the property to tenants. I do my best to provide my tenants with a nice place to live in exchange for monthly rent payments.

    I then use those rent payments to pay back the loan.

    As my loan balance shrinks, my equity in the property increases. Equity is just another way of saying ownership interest.

    When my equity in a property increases, my net worth increases. 

    4. Real estate investors earn massive taxes benefits.

    When you earn rental income, you must report this income on your tax return. Rental income is treated the same as ordinary income.

    However, the major difference between rental income and W-2 income is that there are a number of completely legal ways to deduct certain expenses from your rental income.

    Common rental property expenses may include mortgage interest, property tax, operating expenses, depreciation, and repairs. We’ll touch on a few of these deductions below.

    With all of these available deductions, the end result is that most savvy real estate investors pay little, or nothing, in taxes on their rental income each year.

    Yes, you read that right.

    I’ll say it again, just to be clear:

    Most savvy real estate investors legally pay nothing in taxes on their rental income each year.

    Do not own rental properties if you want passive income.

    Now that you know the benefits, let’s highlight just how much work is involved in owning rental properties.

    At one point or another, you may have heard someone say, “I want to invest in rental properties for some passive income.”

    Yes, we all want passive income.

    No, investing in rental properties is not passive.

    Think of owning rental properties as a way to earn “semi-passive” or “partially-passive” or “somewhat-passive” income.

    Don’t think of owning rental properties as a way to earn “passive” income.

    If you want passive income, you should be investing in index funds, like VTSAX. For more on investing in the stock market, you can check out my series on investing here.

    For me, the benefits of owning rental properties significantly outweigh the downsides of being a landlord. It’s a tradeoff that I would happily make again and again.

    How does the old saying go? “If it were easy, everybody would do it.”

    Being a landlord is not easy. It’s definitely not for everyone.

    But, then again, neither is financial freedom.

    In the end, if you are willing to put in the effort, owning rental properties will accelerate your journey to financial freedom.

    Do you still want to own rental properties after knowing the benefits and the work involved?

    Now, you know the main benefits and the work involved with owning rental properties.

    Like I said, owning rental properties is not for everyone. It takes time and effort to learn the basics.

    Then, it takes more time and effort to do your research and develop a strategy.

    At some point, you’ll need to take a chance and make a purchase. That means putting your hard-earned dollars at risk.

    None of this will be easy.

    But, it sure is a lot of fun.

    And, there is a lot of upside.

    If you still want in, I’m going to help you get started.

    for rent sign in window reflecting that all rental property investors need other know their why before they start buying.
    Photo by Aaron Sousa on Unsplash

    Ask yourself: what are my main goals in owning rental properties?

    Before you start analyzing deals, you need to think long and hard about what your goals are.

    Depending on what your’e trying to accomplish, your strategy is going to be different.

    For example, are you looking to move to an expensive neighborhood and just want to offset your ownership costs?

    You may benefit from owning a home with a coach house, granny flat, or garden unit. You can then live in the primary unit and rent out the second unit to reduce your monthly costs.

    Or, your goals might be to leave full-time employment and use rental property cash flow to fund your life. In that case, you’ll need a property that generates significant cash flow, possibly at the expense of personal comfort or long-term gains.

    On the other hand, you may love your job and have no plans of leaving anytime soon. You’re not concerned about present day cash-flow. Instead, you’re looking for long-term gains through appreciation, debt pay-down, and tax benefits.

    In this scenario, you may target markets that have shown strong growth but don’t necessarily cash flow.

    These are just a few possible considerations. One of the things I love most about investing in real estate is how many options there are. It’s up to you to decide what options are most attractive for your goals.

    This is why the first step is to think and talk about why you want to own rental properties.

    Don’t ignore this first step. Spend some serious time thinking about what you’re trying to accomplish.

    Because different properties may offer different benefits, you need to commit to a strategy before you start worrying about how to analyze specific deals.

    Too many beginner investors skip this step and realize much too late that a property they bought doesn’t help achieve their goals.

    My goal in owning rental properties is to accelerate my journey to financial freedom.

    My wife and I invest in rental properties in Chicago and Colorado to accelerate our journey to financial freedom.

    In order to be truly financially free, we need cash flow to cover our present day expenses. So, we’ve targeted properties in Chicago that generate strong monthly cash flow.

    Don’t get me wrong, we certainly hope to benefit from appreciation, debt pay-down and tax advantages. That’s why we’ve chosen to invest in neighborhoods that we think are only getting better.

    However, we view those long-term gains as more of a bonus. Our focus with our Chicago properties is on present day cash flow.

    On the other hand, our Colorado property is a long-term play. It does not generate positive cash flow. That said, we use the rental income to help offset our ownership costs.

    We are planning to keep our Colorado condo in our family for decades to come. Offsetting the ownership costs with rental income will help us accomplish that goal.

    At the same time, we are hoping that our Colorado condo appreciates in value, making it a solid long-term investment. So, even though it does not generate cash flow for us, it still fits into our long-term plans for financial freedom.

    One key point: just because my wife and I invest for cash flow doesn’t mean we are planning on leaving full-time employment.

    I am a big proponent of all lawyers and professionals having multiple streams of income. I refer to these various income streams as Parachute Money.

    Because my wife and I are earning steady paychecks, we’ve been able to use our cash flow for other investments. We have multiple income streams and are putting all those income streams to work. That’s one reason we’ve been able to scale our portfolio so quickly.

    What are your goals in owning rental property?

    You now know the benefits, the work involved, and some different strategies to consider regarding rental properties.

    Now, it’s time to ask yourself why you want to own rental properties.

    Once you figure out the “why,” you can then move onto the “how.”

    So, if you’re considering owning rental properties, what is your why?

    What goals are you trying to accomplish?

    Let us know in the comments below.

  • Invest in Real Estate for Wealth Through Appreciation

    Invest in Real Estate for Wealth Through Appreciation

    We previously looked at the main reason I invest in real estate:

    Rental property cash flow is king.

    With cash flow, you can cover your immediate life expenses. For anybody hoping to reach financial freedom, it is essential to have income to pay for your present day life expenses.

    For my money, cash flow from rental properties is the best way to pay for those immediate expenses.

    What if you don’t need your cash flow to cover your immediate life expenses? Maybe you have a full-time job that provides more than enough.

    That’s even better. There’s no rule that says you have to spend your cash flow.

    If your present day expenses are already covered, you can use your cash flow to fund additional investments. That might mean buying another rental property or investing in another asset class, like stocks.

    The point is cash flow gives you options. Having options is never a bad thing, right?

    That’s why cash flow is the number one reason I invest in real estate.

    However, cash flow is not the only reason.

    I also invest in real estate to generate long-term wealth for me and my family.

    I am a buy-and-hold real estate investor.

    That means when I buy a property, I intend on keeping it for many years. Circumstances may change, of course, but my intention is to hold property for a minimum of ten years.

    The reason I buy-and-hold for the long term leads us to the next major reason I invest in real estate:

    Appreciation.

    While cash flow can provide for my immediate expenses, appreciation is all about the long-term benefits. Appreciation is how I will generate long-term wealth for my family through real estate.

    Today, I want to talk about what appreciation is and how it can significantly improve your net worth over time.

    Let’s dive in.

    What is appreciation in real estate?

    Appreciation simply refers to the gradual increase in a property’s value over time. 

    For example, if you buy a property for $500,000, and some years later it’s valued at $750,000, your property has appreciated by $250,000.

    That means through appreciation, your net worth has increased by $250,000.

    Except for when you’ve forced appreciation (we’ll discuss below), you have earned that money through appreciation by doing very little. All you have to do is make your monthly mortgage payments, and let the market do the rest.

    This is exactly how many Americans generate significant wealth over time.

    Mini house and key illustrating how to generate long-term wealth through real estate with appreciation.
    Photo by Tierra Mallorca on Unsplash

    How to target properties with a strong likelihood of appreciating is beyond the scope of this post. I’ll soon share with you my criteria, but there’s no one way to do it. 

    Entire websites and books have explored this topic. If I were just starting out, I would spend a lot of time on BiggerPockets.com.

    For that matter, even as an experienced investor, I still spend a lot of time on BiggerPockets.

    For now, remember one main point when it comes to appreciation:

    Appreciation takes time.

    Successful real estate investors know that appreciation takes time.

    I’m not talking about speculators or gamblers. I’m talking about people who are interested in building long-term wealth for their families.

    To build long-term wealth through real estate, you need to remember this main rule about appreciation.

    It’s so important, it’s worth repeating:

    If you can hold a property for years or even decades, you have a really good chance of that asset being worth significantly more than when you paid for it.

    Your property may not appreciate at the same rate every year. Some years, your property may even lose value. That’s OK because you’re in it for the long run.

    The hard part is just holding on long enough to realize the benefit of appreciation.

    In this way, investing in real estate is like investing in stocks.

    How is investing in real estate like investing in stocks?

    Many of the same fundamentals apply to investing in real estate as to the stock market.

    We just mentioned one of the biggest keys with either asset: the longer you hold that asset, the more that asset should eventually be worth. 

    With stocks, we’ve already spent a lot of time in the blog discussing why you need to invest early and often.

    For more information on investing in stocks, you can read a variety of posts here.

    When you invest in stocks early and often, you can benefit from compound interest and safely ride out down market cycles. The stock market does not always go up every year, but given enough time, it does always go up.

    In large part, the same is true when you invest in real estate.

    If you buy good properties in good markets, given enough time, your property should appreciate in value. Like with stocks, the key is your ability to hold on and ride out down market cycles. 

    Want to know the secret to riding out down markets?

    Cash flow.

    You saw that one coming, didn’t you?

    Cash flow will help you ride out market cycles and benefit from appreciation.

    When you own strong, cash flowing rental properties, the cash flow covers all the expenses.

    That means you can stay patient in down markets because holding that property is not costing you any money.

    To take it a step further, as long as your property is cash flowing, you can hold it for decades and generate massive wealth through appreciation.

    Cash flow and appreciation working together is a powerful force. You can see why real estate investors get so excited about their investments.

    When a property is performing, the cash flow allows an investor to hold that property indefinitely. During that time, the property becomes more valuable through appreciation.

    It’s a beautiful partnership.

    What is forced appreciation?

    I mentioned earlier that there is one other form of appreciation worth talking about here: forced appreciation.

    Forced appreciation is when you improve your property in such a way that it increases in value. 

    Common examples may include remodeling the kitchen or bathrooms or adding another bedroom. When you make these enhancements to your property, your property should increase in value.

    This is what house flippers do. They buy a property in need of some work, do the improvements, and then aim to sell that property for a profit.

    It’s not a strategy that I personally use, but it has worked for many people for many years.

    The thing is, forced appreciation is not just for house flippers or investors hoping to realize a quick profit.

    When done correctly, forced appreciation is another way to make money over the long-term for buy and hold investors, like me.

    For example, in one of our rental buildings, we added in-unit washers and dryers. By doing so, our units now command a higher monthly rent, which in turn increases the value of the property.

    As a final point, forced appreciation is one way investing in real estate is different from investing in stocks.

    When you buy real estate, you are in control. You decide what improvements to make and not to make. Many real estate investors love having this type of control over their assets.  

    By contrast, when you own stock in a company, there is very little (if anything) you can do to impact how that company is run. Unless you have boatloads of stock in a particular company, you’re essentially just along for the ride until you sell your stock.

    What do you think about generating long-term wealth through appreciation?

    Now you know two of my favorite reasons for investing in real estate: cash flow and appreciation.

    Have you invested in real estate and benefited from appreciation?

    Did you force appreciation or hang tight and let the market do it’s thing?

    Let us know in the comments below!

  • Invest in Real Estate Because Cash Flow is King

    Invest in Real Estate Because Cash Flow is King

    You may be wondering whether it’s better to invest in real estate or the stock market.

    It’s a valid question. We all have limited dollars (some more than others) and need to decide what to do with those dollars.

    The debate between investing in real estate or stocks is a good one. There’s no doubt that both asset classes can provide significant long-term growth.

    There are also advantages and disadvantages to both types of investments. Advocates on either side of the debate can be very passionate about their preferred asset class.

    I personally invest in both asset classes. I have 10 rental apartments in Chicago and a rental ski condo in Colorado. In addition, I invest in the stock market primarily through index funds.

    Both asset classes play a key role in my journey to financial freedom. From my perspective, you don’t have to choose one asset class over the other. You can invest in real estate and own stocks.

    We’ve spent a lot of time in the blog already talking about the significant long-term upside of investing in the stock market. If you need a refresher, check out my post on investing early and often to benefit from the magic of compound interest.

    Today, I want to discuss one of the main reasons to invest in real estate. The reason comes down to a simple term:

    Cash flow.

    When investing in real estate, cash flow is the money left over each month after paying all your bills.

    There’s an old saying, “Cash is king.”

    For me, “Cash flow is king.”

    My goal is to use real estate to accelerate my journey to financial freedom. To that end, I invest in real estate primarily for the cash flow.

    Let’s dive in.

    Stocks and real estate will each provide incredible long-term benefit.

    Both stocks and real estate can provide significant long-term upside. Besides that upside, I invest in real estate for the immediate benefits of cash flow.

    In terms of your Budget After Thinking, your Later Money is for future expenses. Your Now Money and Life Money are considered immediate life expenses.

    Let’s talk about the Later Money category for just a moment. We can hopefully agree that both the stock market and real estate investments can generate incredible long-term wealth.

    The S&P 500 has historically provided an average annual return of 10%. While not guaranteed to continue in the future, 10% average annual returns represents a powerful wealth generator.

    With real estate, the long-term prospects can be harder to sum up with one simple number. There are a lot of variables at play, not least of which are the type of real estate and the geographic market.

    For example, I primarily invest in small multi-family properties in Chicago. According to Redfin, residential home prices in Chicago were up 9.1% compared to last year.

    Certain neighborhoods in Chicago have fared even better. In the neighborhood I invest in, prices are up 11.1% since last year.

    Those are nice short-term trends.

    On the other hand, in the past 25 years, home prices in Chicago have only doubled, which actually lags the national average. That’s not so nice.

    By the way, you can find data like this for most markets across the country so you can do your own homework on your market.

    So, what’s the takeaway?

    For me, it’s quite simple:

    If you hold real estate for long enough (think decades, not years), it will go up in value.

    Given enough time, like the stock market, real estate always goes up.

    How much your real estate will increase in value is hard to predict.

    My expected long-term returns in Chicago are different from somebody who invests in condos in San Francisco. Likewise, my Chicago rentals are different from my Colorado rental ski condo.

    I don’t expect my Chicago properties to increase in value at a rate of 10% over the long-term. I certainly hope the value of my properties beat the historical average in Chicago, but I’m not expecting that either.

    The point is, whatever happens long-term, I’m OK with it. The reason I invest in Chicago rental properties is not really about the long-term upside.

    It’s about the cash flow.

    For me, cash flow is king.

    Cash flow is king because it can cover present day expenses.

    To be truly financially free, you need to cover immediate life expenses at the same time you are saving for future life expenses.

    My definition of being financially free means not being dependent on the income from a primary job to cover your life expenses.

    My goal is to be truly financially free. That means I need money to pay for my life now, not just decades from now.

    African lion photography by Bisakha Datta symbolizing that cash flow is king when it comes to financial freedom.
    Photo by Bisakha Datta on Unsplash

    We just talked about how the stock market and real estate can both help with the future life expenses.

    For me, the primary benefit of investing in real estate is to help with those present day, immediate expenses.

    In terms of your Budget After Thinking, that means helping with your Now Money and Life Money.

    This is where cash flow comes in.

    I can use the cash flow from my rental properties to help cover my present day expenses. By having cash flow available in this way, I have accelerated my journey to financial freedom.

    In fact, I’ve been hard-pressed to find any other asset class that provides as many benefits in the here-and-now, while also providing benefits in the future.

    Let’s explore that point next.

    I prefer cash flow from real estate over stock dividends for my current expenses.

    Don’t get me wrong, you can certainly reach financial freedom by investing in the stock market. As we just talked about, the stock market provides significant long-term upside.

    Plus, you can certainly cover your current expenses with dividends from your stock investments.

    However, I think cash flow from real estate is a better option.

    Here’s why.

    In order to fund your current life with your stock investments, you either need to withdraw some of your earnings or even sell some of your stocks.

    When your stock portfolio is growing, you can leave your principle untouched and live off of the earnings. That’s pretty nice.

    But, what happens when the market drops? You still have bills to pay and a life to fund. To cover those expenses, you may need to sell some of your stock assets.

    Selling assets is not a great way to sustain long-term wealth.

    With real estate, you can live off of the cash flow without having to sell the asset.

    While your property may go through periods where it decreases in value, if you keep it long-term, the asset will increase in value. During that time frame, you can use the cash flow to fund your life.

    Let’s explore this concept a bit further with an example using the popular 4% Rule.

    What’s better for monthly expenses: cash flow from real estate or dividends from stocks?

    Let’s say you just received a windfall of $250,000. Pretend it’s a bonus from work or an inheritance from a distant relative.

    Your goal is to achieve financial freedom as soon as possible so you are not dependent on your W-2 job.

    You are considering two investment options.

    Option 1: You invest the $250,000 into a total stock market index fund, such as Vanguard’s popular offering (VTSAX).

    You’ve done your homework and know that based on the 4% Rule, you can safely withdraw 4% of your money in the first year and then 4% plus an adjustment for inflation in subsequent years. If you do so, your money should last 30 years.

    That means you can safely withdraw $10,000 in the first year year, and a bit more each year after that. For simplicity, let’s just look at the first year when you can safely withdraw $833.33 per month ($10,000 / 12 months = $833.33).

    Remember, your goal is to leave your primary job. With this investment, you can assume you’ll have $833.33 per month available to cover your monthly expenses. Not too bad.

    One important note: the 4% rule contemplates that your original investment should fund your lifestyle for 30 years. Importantly, there’s a chance your portfolio may be completely depleted after 30 years.

    There’s also a chance your portfolio may be worth more in 30 years than when you started withdrawing.

    Your results in large part depend on the percentage of stocks you own in your portfolio. If you are interested, you can read more about the 4% Rule and successful withdrawal rates here.

    One of keys to remember is that while the market does not always go up every year, you will still be making withdrawals every year.

    There may be a year where the market drops by 5% on top of the withdrawals you made that year. When that happens, your account balance drops. If you are not flexible in your withdrawal rate, this could lead to problems.

    True, when the market goes up, your account balance goes up. The 4% Rule attempts to factors in these up-and-down cycles over a 30 year period.

    However, when you are making constant withdrawals over a long enough period, there’s a chance that your account balance will eventually drop to zero.

    Keep this in mind as we consider our next option.

    Option 2: You use the $250,000 for a down payment on a rental property valued at $1 million.

    We will soon learn how to evaluate rental properties. Countless books have been written on the broad topic, and it’s beyond the scope of this post.

    Humor me for now since this is only a hypothetical scenario.

    Without getting into specifics, I am willing to bet that any decent real estate investor could generate more than $833.33 per month from a $1 million property.

    Personally, if I had $250,000 to invest in Chicago, I would not settle for anything less than $2,000 per month in cash flow. And, that would be the bare minimum for me to even tour a property.

    With an initial investment of $250,000, my focus would be on finding a rental property with at least $3,000 in monthly cash flow.

    For now, you’ll just have to trust that cash flow like that is possible with rental properties. I’ll soon show you how to do the analysis and manage your properties to target returns like this.

    Photo from Zach Angelo created for his church symbolizing that cash flow is king when it comes to financial freedom.
    Photo by Megan Watson on Unsplash

    To recap, with the same $250,000 investment, you should be able to earn more monthly cash flow in real estate than dividends from stocks.

    It gets even better.

    If you hold your property long-term, your monthly cash flow should increase over time. Over those 30 years, inflation will naturally cause your rental income to increase.

    At the same time, if you have a fixed rate mortgage for 30 years, that major expense stays constant. The difference between your increased rental income and constant mortgage payment results in more cash flow.

    So, if you are hoping to sustain financial freedom without a primary job, which investment gets you closer to covering your monthly expenses?

    Investing in real estate offers so much more than just cash flow.

    Don’t stop reading yet.

    On top of the monthly cash flow, real estate provides so much more.

    Here’s a sneak peak continuing our prior example:

    After 30 years, you will own an asset without any debt. In our example, even without any appreciation, you would own a $1 million property debt-free. And, that debt was paid off entirely by your tenants.

    Add in appreciation, another major reason to invest in real estate, and your property will likely be worth $2-$3 million debt-free after 30 years.

    Compare that to the example with stocks using the 4% Rule. After 30 years of depleting your investment account, your investments may be gone.

    To put a bow on this point:

    With stocks, you can earn $833 in monthly dividends and possibly have no money left after 30 years.

    With real estate, you should reasonably earn $2,000-$3,000 per month (improving over time), and after 30 years will own an asset worth $2 million-$3 million, debt free.

    When you look at it this way, the choice is really not that hard, is it?

    On your journey to financial freedom, are you convinced that cash flow is king?

    I’m not saying it’s bad to invest in stocks or you should only invest in real estate. I personally invest in stocks and real estate.

    I see a place for both asset classes in my future.

    If you haven’t previously considered investing in real estate, maybe you’ll now think about how that monthly cash flow can fit into your overall investment portfolio.

    If you’re striving for financial freedom, are you convinced that rental property cash flow can accelerate your journey?

    Let us know in the comments below.