Buying Rental Property – Desirable or Detrimental?Money
Running Out of Money
Many seniors have some money saved but are having to take out say $1,000 or $2,000 per month for expenses. It is not much but we know that eventually there will be no money left to take. Not only will we run out of money but inflation is eating up the money we have.
The interest rate is low right now….
So if you worked hard during your lifetime and had counted on the interest from the money you had put away to help with your daily expenses, well, we all guessed wrong. It is doubtful that we will see interest rate rise during our lifetime.
We Need More Monthly Money
Now we must figure a way to get more money from what we have. Buying rental property is one way but it is not for everyone. There are two reasons to invest. One, the real estate will be worth more tomorrow than it is today and when you sell it you will reap the benefits. Maybe and maybe not.
The value of your asset should go up….
It does not always. If you are lucky and purchase the right property at the right time and someone else wants what you have, the answer is yes. You really just have to be lucky. It is hard to spend your hard earned savings hoping for luck. Sometimes that may be all you have.
Monthly income should increase over time….
The second reason and the reason we must consider this is for the monthly income we need to survive. Inflation has taken a lot of our buying power and will continue to take more. We must do something.
Let’s assume that you have $300,000 in savings. If you use $1,500 of that money per month, it will last approximately 16 and a half years but what about at the end of the 16 years? What about inflation during those years. $1,500 in 10 years will purchase much less than it does now.
If you purchase a home for $300,000 that will bring in rents of say $2,000 a month. At $2,000 times 12 you will reap $24,000 per year. Insurance will cost about $900 per year and taxes may cost $3,600 per year. We can assume vacancies at 10%. That leaves us with $17,100, or $1,425 per month. $17,100 divided by our investment of $300,000 = 5.7%. That is a great rate! Now we are getting 5.7% on our money. More than we planned on when we put the money away.
A Different Calculation
Let’s think about this differently. Assume you can buy that same home for $300,000. But now let’s borrow $150,000. Same scenario but now we have to add the mortgage payments of $720 times 12 = $8,640, assuming a mortgage rate of 4%. Our new take home is $8,460 or $705 per month. Divide $8,460 by $150,000 (our cash investment) and we get a return of 5.6%. We still have $150,000 to save, spend, or purchase another home. When the mortgage is paid we will have that extra $720 per month and since rents should go up, we should have even more money that we calculated.
Buying Rental Property
Sounds so good and so easy….
Hold on, it does not always work that way. Buying rental property does not always turn out so well. What if we can not rent the house? What if we rent it and the tenants do not stay? What if the tenants tear up the house and we have to do a lot of repairs? What if the air conditioner goes out and we have to replace it? What if the neighborhood turns down and no one will rent the home? What if the house stays empty for a long period of time? Our payments do not stop. We still have to pay the mortgage, the taxes, and the insurance. Problems, problems, problems.
We still have to sleep at night. This buying rental property is not for everyone. Let’s add another item to the mix. We do not want to take care of the tenants so we hire a property manager to take over the management. That will cost about 10% of the gross rentals. Now we get $6.060 ($8,460 – $2,400, cost of the manager) per year. That percentage comes to 4.04% ($6,060 divided by $150,000). Not as good as before but better than leaving our money in the bank.
Another change is if we put away 10% of the monthly income for contingencies. That will give us a cushion when something happens, and it always does. Now we keep $6,060 less $2,400, or $3,660. Divided that by our investment of $150,000 equals a mere 2.44%. Terrible for the risk we are taking but better than the .02% the bank gives us on our deposits. But now the money is not available in case we need it so there are always trade-offs.
The moral of all this is that it can be beneficial to buy rental property. Take a pencil, paper, and calculator and figure it out on paper first. Then go look for a decent house to buy and do your due diligence. No one cares about your money like you do.
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