Multiple Streams of Benefit Flow to Long-Term Rental Owners

One of the most attractive aspects of owning real estate long-term is that financial benefits flow to the owner in a variety of ways, and accumulate continuously with the passage of time.  Rental properties certainly require some regular attention, but this can be minimized with the help of a good Property Management company.  It takes time and energy to build an effective management team, but once in place, the investor can "tend to the crop" with minimized energy expenditure and free up time for other pursuits, while the real estate portfolio continues to grow.

Just as a healthy person develops the habit of exercising regularly and comes to enjoy it, a real estate investor develops the satisfying habit of intelligently managing his/her portfolio.  As the months and years go by, rental properties deliver increasing value through the following streams:

1) Cashflow
This is the most important attribute of an investment deal, because without positive cashflow, the investor would have to be actively earning money elsewhere in order to regularly pay-in to the "investment" property.  When there is positive cashflow (which must exist above all expenses including mortgage, property taxes, insurance, repairs, property management, and vacancies), a property is able to fund its own existence while delivering cash into the owner's pocket every month.  When there is positive cashflow, a property becomes like a mostly-independent "worker" that is capable of earning money and sending it to the owner on a monthly basis.

2) Appreciation
Property values can oscillate in the short term, but tend to go up in the long term.  If a $300k multifamily property appreciates by 4% a year for 3 straight years, all the sudden the property is worth $337k.  This $37k belongs to the owner and feels like a bonus because it is exists on top of the primary benefit of cashflow.  The owner can tap into the equity through refinancing or adding a home equity line, which gives a chunk of cash to the owner for use acquiring new rental properties or for renovating existing ones.

3) Principal Paydown
Unless an interest-only loan is used to a hold a property, the monthly mortgage payment will include some portion of interest and some portion of principal.  In the beginning, the monthly payment is mostly interest, and a little bit of principal.  But with time, the principal portion increases.  So, each month, as the mortgage expense is paid, the remaining principal is being chopped away, increasing the equity in the property accordingly.  This equity can then be tapped into via a refinance or equity line.  Even though the monthly mortgage payment is rightly considered an expense, some of that expense goes back to the owner in the form of principal pay-down.

4) Rent Increases
In attractive areas, rent tends to rise over the years.  So as rent goes up, and the mortgage payment stays steady, cashflow increases.  A property that delivers $500/mo cashflow in the beginning might deliver $1000/mo cashflow 10 years later through gradual increases of rent.

5) Tax Write-offs
At a normal corporate job, the employee is paid via W2 income and taxes are taken out of the employee's check.  In the case of rental income, the gross rent amounts are delivered to the owner and it is up to the owner to pay quarterly taxes based on the estimated annual amount owed.  Unlike W2 income where there aren't many significant writeoffs, a rental property owner can write off mortgage insurance and depreciation.  Depreciation particularly goes a long way to offset rental income and reduce income taxes.  So, even while the property is going *up* in value, the owner can write-off depreciation and reduce income tax owed.  So, $65k in rental income might be equivalent after-taxes to $90k in earned income from a job due to the tax differential. Another tax benefit comes when it is time to sell a rental property. The profits of the sale can be "rolled up" into a more expensive rental property (through a 1031 tax-deferred exchange), thus avoiding the necessity to immediately pay taxes on the equity accumulated through appreciation and principal pay-down.

6) Property Improvements
Incremental improvements can be performed on a rental property to increase the rental income.  For example, when it's time to replace appliances, stainless steel could be installed and the rent increased by $50 due to tenants being more attracted.  Or, a previously unused garage could be leased out for $100/mo to someone who needs a place to store and repair a motorcycle.  An unfinished basement could be renovated to add extra bedrooms and increase the rent of the unit.  With other types of investments such as stocks or mutual funds, the investor gives over the principal investment and then waits and accepts whatever returns come.  In real estate, the owner can creatively perform improvements to increase the monthly income from the property.  And in the case of commercial properties (5-units or more), the income helps to define the appraised value. So, an increase of income also increases the value of the asset.

Conclusion
When buying a rental property, I endeavor adding immediate cashflow and equity to my portfolio at the moment a property is purchased.  In addition to the satisfaction of immediate results, it is fulfilling to know that the initial performance should be the worst financial position of the property, and the subsequent years of ownership will produce ever-increasing positive results. When analyzing a property, I like to keep in mind that if I can setup positive cashflow and a healthy equity position from the beginning, the future will look very bright!