The Amazing Benefits of Rental Real Estate

February 3, 2014

RentalThe stock market closed out 2013 with a new high. There’s certainly a lot of buzz around the market right now, but often that’s one of the best times to start seriously investigating alternative investments. As the saying goes, what goes up, must come down.

That doesn’t mean that the stock market is headed for a fall, but record price levels tend to be difficult to sustain. That means that now may be an excellent time to get really serious about diversification. One alternative with amazing benefits is rental real estate.

A lot of people have soured on real estate as an investment since the housing and mortgage collapse a few years ago. But it is for that very reason that rental real estate is still well priced in a lot of markets. It’s still possible to buy rental real estate for a lot less than you could have before 2007. And there are a lot of reasons why you might want to.

Investing for Income and Appreciation

Fixed income investments provide income. Stocks – mostly – provide appreciation (high-dividend-paying stocks are an exception). But rental real estate provides both income and appreciation. You can earn an income from a positive cash flow by charging rent, while the property gradually rises in price over many years.

But rental real estate as an added dimension in the appreciation department, one that even high dividend paying stocks don’t have, and that’s leverage. Most of the purchase price of a rental property is provided through a mortgage. That may enable you to buy a $250,000 rental property with just $50,000 in cash. And even if the property doesn’t rise in value, amortization of your mortgage balance virtually guarantees that your equity will rise as the years pass.

Investing in a Real Asset

The world is awash in paper assets; but sometimes having an investment that you can see and touch feels better sitting in your portfolio. Real estate is just such an asset, which is why the very name includes the word real.

Paper assets represent claims on physical assets (in the case of stocks), or promises to pay (debt securities, like CDs, bonds, government securities, etc.). While the assets behind the paper may be real, the value of the paper can fluctuate wildly due to the fact that it trades on open markets. The price of a stock can crash to near zero and a debt security could fall all the way to zero if the issuer defaults.

But because real estate is a physical asset, it has value all its own. This is particularly true of rental real estate. The property will always have value for housing purposes, and the fact that it is investment property means it will alway generate cash flow from rents. Real estate is a real asset in much the same way gold and silver are, except that it also offers the possibility of producing income. In a sense, it’s the most real of all real assets.

Rental Real Estate Becomes a Cash Machine When . . .

One of the biggest advantages rental real estate provides comes when the mortgage on it is paid in full. Once it is, a far greater portion of the rental income will flow into your bank account. Though many people buy investments in hopes of making a short-term gain, rental real estate may be the very best long-term investment. Quite literally, as soon as the mortgage is paid off, the property becomes a cash machine.

Unless the property is located in an area with extremely high property taxes, the mortgage payment itself is almost certainly by far the biggest carrying cost in owning the property. It is conceivable that once it is paid off, the majority of rent from the property will become pure profit.

A Superior Retirement Supplement

One of the biggest enemies of retirement planning is inflation. Though stocks are very good long-term inflation hedges, they often perform poorly during periods of relatively high inflation, for the simple fact that the stock market hates the uncertainty that inflation creates. Real estate, on the other hand, tends to flourish in higher inflationary environments. That makes it one of the best investments you can own going into retirement.

Not only is there the prospect of greater price appreciation from inflation, but there is also the likelihood of higher rental income. Since rents tend to move in pace with inflation, it is likely that the income your property will provide will increase considerably over time. This will be especially important once you retire, since you will need investment assets that will provide you with some sort of hedge against inflation. After all, you won’t have an earned income to help you cope with rising prices any more. Rental real estate may be the single best investment you can hold in dealing with inflation, particularly once you retire.

A Cash Windfall When You Sell

One of the biggest benefits to owning rental real estate is that when you sell it you can collect a huge cash windfall. Sure, you can generate windfalls by selling stocks, but selling a house would generate a single very large gain that they can be life-changing. It is one that is almost certain to happen if you hold on to the property long enough to pay off the mortgage.

This can also have significant implications for your retirement. If you invest in rental real estate when you are in your 20s and 30s, by the time you hit your 60s the mortgages on the properties will be paid. The sale on those properties will then generate enormous windfalls that might fund your retirement all by themselves.

I’m not suggesting that you abandon fixed income assets and stocks in your investment portfolio. Only that you add rental real estate as part of your investment diversification strategy. It can provide financial benefits that no other investment can.

Have you considered investing in rental real estate in the current market? Leave a comment!

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Kevin

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Kevin
Kevin Mercadante is professional personal finance blogger, and the owner of his own personal finance blog, OutOfYourRut.com. He has backgrounds in both accounting and the mortgage industry. He lives in Atlanta with his wife and two teenage kids and can be followed on Twitter at @OutOfYourRut.

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2 Responses to The Amazing Benefits of Rental Real Estate

  • Mario DebtBLAG

    A comment on this–I invested in a small fourplex in texas in my early twenties and held onto it even through debt. Now the value is appreciating and the mortage is completely paid off. Now I only have student loan debt and the income from my property is doing wonders in increasing my net worth with regards to that. Great post!

    • Kevin Mercadante

      Hi Mario – Imagine having a few similar properties going into retirement? Small residential rental real estate is one of the best investments available. It just isn’t as simple to handle as paper assets, so you have to be prepared for it.

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