Statistically speaking, there is only a 1% to 3% chance that you will be able to retire with all of the money that you need by age 65! The vast majority of Americans are simply not saving ANY money. One of my original financial mentors told me that most people that do retire with any considerable wealth, accumulated their money from owning their primary residence and other income properties. The reason why these two methods of accumulating wealth are so effective is because they come as monthly bills that you simply must pay, and, there is a considerably penalty if you stop making your payments.

Since many of you already own a primary residence, let’s turn our attention to rental properties. There are 4 ways that investors can make money with rental properties; The 1st way is from a positive cash flow. You have a positive cash flow when the rent that you collect exceeds ALL of the expenses of owning a rental property. Your expenses will include (but are not limited to) your mortgage, taxes, insurance, vacancy rate, all repairs and maintenance costs, advertising & signs, legal and accounting costs, gas and wear & tear on your car from your being the property manager, or hiring a property manager, etc. In the beginning years you should not expect to have a positive cash flow, unless you are prepared to invest a substantial down-payment. Since Portland real estate has appreciated at a much higher rate than rent increases, in recent years, you will most likely have a negative cash flow for a period of several (and possibly more) years..
You MUST be able to afford this negative cash flow or you simply should NOT own rental property. However, if you can afford the negative cash flow, I will show you how profitable rental properties can be over time. Of course, you will try to raise the rent every year by a 3% to 5% increase (or whatever the market will bear) and eventually you will begin to receive a positive cash flow.

The 2nd way you will profit is from having your tenants pay your mortgage for you. Due to the way that lenders calculate interest, you actually pay more interest in the beginning of your loan that you do later on. For this reason, the amount your mortgage is reduced is not as big as you might think, but again, this amount gets bigger and bigger over time.

The next way you profit is from tax benefits. Previously called Depreciation, now called Cost Recovery, the government really likes it that you are providing housing to those who can not afford to own. They let you write off the entire purchase price against your income. You can not do this all at once but over time (currently 27.5 years). So if you bought a property that costs $275,000 you would get a $10,000 tax write off against your income. The higher your tax bracket, the better the benefit. As you can see, if you own a handful of properties you can shield much of your income from taxes. As I am not an accountant and can not give tax advice, you must check with your tax adviser before purchasing any investment real estate to see how this will affect your specific tax situation. Plus, this benefit is temporary. Just as your money grows tax deferred in a traditional IRA account and you pay taxes as you receive the money many years later, you will also have to pay the taxes (called capital gains) when you sell the property. I do not have enough space to explain why this is still a great benefit but feel free to call me and ask me about this.

The final way you will profit is from Appreciation. Right now, Portland is appreciating at record high rates, but if you read my last article, you saw that Portland has averaged a little over 7% since 1991. So let’s use that number and see what happens if you buy an average home.

The median price (half sell above & half sell below) is about $250,000. Let’s assume you use a 10% down payment and have a mortgage of $225,000. With an interest rate of about 6.75 (higher for non-owner occupied). your principal & interest payment for 30 years will be about $1,460. With taxes and insurance it will be around $1,750 per month. Let’s assume you can rent the property for about $1,000 per month. You are now the proud owner of a $9,000 per year negative cash flow. At the end of the first year: 1) You should get a tax write-off of $9,000 off against your taxable income. Assuming a 25% tax rate this comes out to $2,250. 2) Your mortgage will be reduced by $2,400. 3) Your home should be worth $267,500. Let’s add it all up and see how you did.

$2,250 (tax write-off) $2,400 (mortgage reduction) $17,500 (appreciation) = $22,150 – $9,000 (negative cash flow) = $13,150 equity growth on your initial investment of $25,000 down. This is a 52.6% rate of return! If you could average 10% appreciation over time, then the amounts change to $20,650 equity growth and an 82.6% return on your original investment. Plus, your mortgage reduction gets bigger every year, your appreciation grows compounded, and your negative cash becomes smaller and eventually turns positive. Please understand that I did not factor in other expenses such as vacancy rates & repairs, etc. This example is to simply have you get the concept. I hope that you have and that you will consider owning a rental property. Of course, real estate, like all investments come with risk. It is absolutely possible to lose money, especially in the beginning before the value of the property grows. Once you get through the first 2 or 3 years it really gets much easier and safer.

One last consideration, the rental market has gotten softer over the last two or three years. As record numbers of renters have been buying their first homes, there are less renters in the market. Also, as more people have been buying rentals, there are more rental homes available. Less demand, more supply. This is what has caused rents to stay low and some vacancy rates to rise. Thusly, it is prudent to have some reserve money in case of any problems.

By the way, the Oregonian just reported on Jan. 17th, 2006 that Portland real estate has appreciated 20.4% from December, 2004 through December, 2005. Wow!

Steve Bennett
Principal Broker, GRI, CRS