Rental Properties - Hidden Profits

Posted by Greg Eckler on Tuesday, July 12th, 2016 at 6:47am.

No cash flow. No appreciation. No Problem. Learning how a rental property is a good investment without any profit or appreciation.

When people consider purchasing a rental property they initially think about cash flow (i.e. their monthly profit) and appreciation of their investment over time. While those are definitely good things to keep in mind, I want to show you how a rental property can still be a great investment when those two factors – cash flow and appreciation over time – are actually zero.

For the purposes of this exercise I want you to assume a few things:

1. The rental income exactly matches expenses so there are zero monthly profits for the owner.
2. The real estate market isn’t appreciating. (Yes, in our current 2016 Denver market that seems crazy, but humor me on this one.)
3. The property is 100% rented, and any major expense is also covered by the rent.
4. Any tax implications are not considered

Again, in my scenario there is no profit – your tenant is only covering your expenses. And while that may not seem like an ideal or profitable investment, I disagree. Let me break down the numbers on getting a loan paid off with your down payment money as your only out-of-pocket expense.

Example 1
$400,000 property
20% down = $80,000
Initial loan balance = $320,000 @ 4% Interest Rate

Each year the renters will pay down a portion of your loan balance – let’s call this the “annual gain.” This gain comes from a lower loan balance at no additional cost to the investor. We can calculate the percent gain by dividing the down payment by the annual gain.

Year Annual Gain Percent Gain
1 $5,635 7.0%
10 $8,072 10.1%
30 $17,936 22.4%

Example 2
$400,000 property
15% down = $60,000
Initial loan balance = $340,000 @ 4% Interest Rate

Year Annual Gain Percent Gain
 1  $5,987  9.9%
10   $8,576  14.3%
30   $19,057  31.8%

In this 2nd example the down payment is lower and the cash flow is still zero, but the result is a higher gain in year 1 and a 31.8% gain by year 30.

Remember, these percents only include minimal rent increases to cover expenses and no market appreciation.

If we remove the assumptions and allow an investor to profit monthly and realize appreciation, the investment only gets better.

NOTE: The percents in my examples, while accurate, are a bit misleading when comparing them to “traditional” investments (i.e. stocks and real estate appreciation) because my examples are simple interest calculations looking at each individual year and not compounded interest calculations.

 

Disclaimer: This representation is based in whole or in part on content supplied by REcolorado®, Inc. REcolorado®, Inc. does not guarantee nor is it in any way responsible for its accuracy. Content maintained by REcolorado®, Inc. may not reflect all real estate activity in the market.

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