Top 5 Reasons You Should Invest in Rental Properties

By Frank Uhler

You worked hard and effectively stashed away a solid portion of your income into savings.  Now comes the question most people struggle with, “how should I invest my hard earned savings?”  In today’s financial markets there are a significant number of investment vehicles for an individual investor to choose from.  Furthermore, interest on savings or money market accounts is historically low.  

Those who diversify their investments into stocks, bonds, ETFs, etc., tend to enjoy the simplicity and speed of online brokerage accounts (I know because I used to be one of these people).  Investing directly in income producing real estate is not as easy as clicking a button, but can produce superior returns as a result.  

For those considering adding real estate to their portfolio of investments, I have included the top 5 advantages of this type of investment.

1. Passive Income – At its core, real estate investing is a purchase of a future income stream. When done correctly, this income stream is often much greater than you could achieve from other types of investments and should increase over time.  Once all of the property operating expenses and debt service is paid for the month, the remaining “profit” is kept by the owner.  This leftover profit is similar to a dividend received from stock investments, which both result in the receipt of passive income.  

OVER THE LONG TERM, PASSIVE INCOME IS A GREAT TOOL FOR BUILDING WEALTH

The cash dividend provided by real estate investments will vary based on several different variables such as: location, property type, competition, risk tolerance, and various other factors; however, many real estate investors attempt to achieve a 6-10% cash dividend on their investment.  This is significantly higher than the average trailing twelve-month dividend yield of the S&P 500 as of March 2017, of 1.97%.  The S&P 500 dividend yield approximates the average dividend paid by companies in the S&P 500.  

For example, if you invest $50,000 of cash into an investment property, and the property produces a cash flow dividend of 8% throughout the following year, you will earn $4,000 of passive income off this investment. If you are able to slowly build the number of investment properties in your portfolio to 10 similar properties, this could eventually result in $40,000 of passive income each year.  Over the long term, passive income is a great tool for building wealth.  


2. Value Appreciation and Stability – Although the market value for real estate is cyclical, real estate tends to be a more stable asset.  Unlike the stock market, there is not a daily quote for individual real estate asset values.  Furthermore, there is lower transaction volume because of the higher costs and longer timeline involved in real estate transactions.  Lastly, the impact of inflation can typically be passed on to tenants in the form of higher rents, resulting in appreciation of the property value.

YOU HAVE A GREATER POTENTIAL TO DIRECTLY IMPACT THE PERFORMANCE OF YOUR INVESTMENT


3. Potential for Value Creation – Unlike stocks and bonds, you have a greater potential to directly impact the performance of your investment.  Full time investors often create additional value, through property rehabs, improved utilization of the space, or superior management, including economies of scale on maintenance and property management staff.  The resulting increase in rent from rehabbing a property typically results in an overall increase to the cash flow and total return of a real estate investment.  Even small improvements to a unit, such as adding washer/dryer or updating a bathroom, can often result in rental increases of a few hundred dollars per month.
 

4. Leverage – The appropriate use of debt in real estate can help you increase returns.  The main advantage of leverage is that the initial capital required to buy a property would typically only be around 20-25% of the price (even less in some instances).  This would allow an investor to purchase a $1M real estate investment property with only $200K of cash. Additionally, your outstanding loan balance is being paid down over time through the rent payments of tenants.

Properties can also be re-financed after the value has increased (whether due to rehab work or strengthening market).  The return of capital through a re-financing will provide an investor with access to equity earned through the amortization of debt, or the increase in the property’s value.  

For example, after 7 years your $1M property has increased in value to $1.23M (approximately 3% appreciation per year) and your outstanding loan balance has gone from $800K to $675K.  If you decide to re-finance your property using a loan that is 75% of the value, then you will receive a new loan of $923K.  Once you pay the old loan off you are left with approximately $248K of proceeds (return of your initial investment of $200K + $48K of additional cash).
 

5. Tax – There are many tax benefits to owning real estate, which differ based on your classification as a passive investor or a real estate professional.  A tax lawyer or accountant should typically be consulted about the specifics of your situation, but I will highlight the general benefits to a passive real estate investor.  The following real estate investment related expenses can be deducted from your taxable income:

  • Mortgage interest expense (for loans to acquire or improve rental property)
  • Repairs & maintenance
  • Depreciation
  • Insurance premiums
  • Casualty and theft losses
  • Legal & professional services
  • Travel expenses (for property related trips)

Deducting these expenses can significantly reduce your taxable income for the year, therefore decreasing your overall tax liability.  


If you read these benefits and are now considering making your first real estate investment, stay tuned for my next blog on the “best ways to invest in real estate.”
 

How I got started in real estate

By Michael Shenouda

There isn’t a month that goes by that I don’t have a coffee or beer with someone who just wants to know how to get started in real estate. My name is Michael Shenouda and I am the founder of Honore Properties, this is my story about how I bought my first building.  

In 2007, I graduated from the University of Illinois and besides getting a job I had one goal:  to buy my first piece of property.  I had taken one real estate class in college and our professor owned 3000+ units on campus; he told us the best way to start is to buy a 2-4 unit, live in one and rent out the other units.  It’s an easy way to see if you enjoy being a landlord because you are also providing a place for yourself to live at the same time. In addition, the process is not much different than buying a single-family home or condo.  The goal was to create passive income and a second income stream for myself.  

In the fall of 2007 I starting looking at 2-4 unit rental properties but prices were very expensive so I also looked at condos for rental purpose.  In 2007 prices were at an all-time peak, I wasn’t terribly focused on value though, my model was and still is to find cash flowing properties.  This was nearly impossible in 2007 especially since my only way of finding deals was through the MLS.  From 2007-2009, I looked online, underwrote, visited north of a 1,000 properties.  I was close a few times to buying but for whatever reason they did not work out.  In July of 2009, I purchased the first two flat I had seen back in 2007 but for 1/3 of the original asking price in a foreclosure sale.   

Now the nitty gritty.  I had no money, no experience, and was barely making 30k a year at the time. My first full year of working in 2008 showed an income of 22k.  I had read 50+ books on being a landlord and investing but otherwise had no idea what I was doing.  One of my friends and I decided to buy this first investment together and be roommates at the same time, making the down payment and income requirements easier.  We used a loan called a FHA 203k.  The property we bought needed rehab and this loan allowed you to put 3.5% of the total cost of acquisition and construction.  In our case, we needed a down payment of approximately $10,000.   

As I mentioned, I had zero savings and was barely able to make rent, floating out checks on the last night of the 5th hoping our landlord wouldn’t pick them up for a day or two until I was able to find some more cash.  (I am not advising this next part in anyway shape or form but just telling my story as a way to show that anything is possible.)  At that point, I took out a 1 year interest free credit card and put all my expenses on it for the few months leading up to the closing.  This allowed me to have the $5,000 needed to close on the property.  

Back then, President Obama was offering $8,000 for first time home buyers so I was able to recoup a lot of this money quickly.  Then we started to rehab the property, a lot of this was done by ourselves and our families that we dragged in to paint and help landscape.  The heavy lifting was done by a contractor we hired.  The contractor took full advantage of me, a wide eyed 24-year old that had no clue what anything cost.  Regardless, we finished the project and were able to rent the other unit to friends from college (one who later became my wife!).

After killing ourselves nights and weekends to get this done as we both still had full-time jobs, we were able to generate $500 a month in cashflow on the building.  So instead of paying $600 in monthly rent, I was able to only pay $350, saving myself that $250 every month.  On top of the $250 a month, we were paying down our loan, receiving tax breaks and hoping for future appreciation.  

I know what most people think at this point as I have heard it before.  You went through 2 years of trying to find something (nights, weekends and any free time I had) and countless hours working on this property just to save yourself $250 a month.  The answer is technically yes, but the experience was priceless.  Now that I had been through the process, built a team, met brokers, I was well poised to do more.  From there I went on to buy a couple 4 unit buildings and then started buying 6, 8, 20, 30 unit buildings.  As I learned to manage these buildings better, the value went up and I was able to leverage appreciation to refinance some equity out of our deals. That cash could then be used to buy more deals.  

After several years of doing this and having a solid track record; I am now able to raise capital and do deals as big as I want.  Honore Properties now has a portfolio of 200 units and is growing quickly.    

But remember it all started with a little 2 flat….I truly believe anyone can do this, it just takes a lot of time and effort to get started.  You don’t need to turn it into a full-time career either, you just have to get started.  No excuses!    
 

 

Honore Properties is a full service real estate company, if you are interested in buying or selling a property you can contact us at (312)-600-4501