Please note, in the video I refer to putting a chart on the screen. Unfortunately, YouTube no longer allows us to link to external pages in the video, so we weren't able to add that link to that chart. Here it is: Rent Prices Compared to Housing Prices
Hi. Todd Ortscheid here with GTL Real Estate.
This week I wanted to talk about why you probably should not sell your rental property. Now, there's been a lot of interest lately, from a lot of our clients, asking us about whether they should start to think about selling. There are some circumstances where it might make sense for you to sell your rental property, but usually that's not the case.
I wanted to go through some of the reasons for that. And keep in mind, from our perspective, we really have no vested interest either way, because we're a full service brokerage, we both sell and manage property. So we're happy to do either for you, but we do want to give you the best advice for what makes the most sense for you financially. So, we wanted to go over why it's usually not a good idea to sell an investment property that you already own, and also why it's probably a good idea for you to acquire more real estate for investments.
So, just to go through a few reasons here. The biggest advantage on real estate compared to other forms of investment, at least income producing real estate like rental properties, is that the tenant is paying for your equity. Of course, this assumes that you didn't pay cash all up front and you have a mortgage that you're paying every month for the property. But assuming that's the case, as it is with the vast majority of our clients, that means you put down a relatively small amount of money in order to purchase that property. So, you might have acquired a $100,000 property, but you only put down $10, $15, $20,000 to buy it.
This is the great thing about real estate that's unlike any other kind of investment. You can accumulate a $100,000 asset at only $20,000 or less, depending on what kind of loan you got. You can't go to Schwab and buy $100,000 of IBM stock for only $20,000. It just doesn't work that way, unless you want to set up a margin account and pay extremely high interest rates, it doesn't really work that way. So, real estate, that is the typical way that people purchase property is through financing. That makes it possible for you to acquire quite a bit of wealth with a relatively minor upfront investment.
The beauty of this, when you're buying a rental property, is that over time the tenant is the one who is paying for your equity. So you put down, say, that $10,000. Let's say you were able to get a 10% down loan, you only put $10,000 down for a $100,000 house. Now, the tenant starts to pay you every month after you get that rented, so their payment is likely more than the amount of your mortgage payment, so when you pay that mortgage payment every month with the money that tenant is paying you in rent, it's that tenant who's actually paying down your equity. They're basically putting money in your pocket. People, at lot of times, don't think about that. The way they look at it is, "Well, I've got this $100,000 property. I'm paying, say, $700 a month for my mortgage payment. The tenant's paying me $1,000 a month, so I'm only getting $300 a month."
I hear this from out clients all of the time. My answer to that is, "No, that's not correct. You're actually getting a lot more than that." Within that $700 a month mortgage payment you're making, a portion of that is principle. It's not all interest. So, when that principle is being paid down, that's money going into your pocket, into your net worth. It's important to keep that in mind that you're actually cashflowing more than it looks like you are. If you were to sell that property five years from now, all of that equity that was paid down would go in your pocket as actual cash.
So, it's important to keep that in mind when paying down your equity. That's the most wonderful thing about buying real estate with financing. The person actually putting the money into your pocket from that investment is the tenant. You're not actually having to buy that $100,000 asset at $100,000.
The next big thing about real estate investing is the tax benefits. With the exception of just a few asset classes that you can buy in municipal bonds and some other things, there's not a whole lot out there that's tax-advantaged other than real estate. Real estate is heavily tax-advantaged.
Some of the examples of that are your mortgage interest ... that's a business expense. Any repairs that you do on the property are a business expense. What you pay us for our management services is a business expense. So, those all get deducted. But the most important thing is depreciation. So, even though we all know the value of property tends to go up over time, the government says property depreciates over time. So over twenty-seven-and-a-half years you're basically taking the purchase price of this property, the original basis of it, and over that twenty-seven-and-a-half years, you're depreciating it, which basically means you're taking a deduction for each year of that twenty-seven-and-a-half years until that property is completely depreciated. The entire value of it, as far as the government is concerned, is gone ... even though you could actually sell that property for a lot more than you original purchased it for.
This is a huge tax-advantage for you. When you calculate all of this up, your mortgage, your depreciation, your repairs, your management fees, your insurance, your taxes ... all of this stuff gets totaled up. Usually what you'll find is that you get a deduction. An actual loss will show on your income tax statement, even though you had free cashflow coming into your pocket. The reason for that is because of the depreciation. Usually, once you have all of your normal expenses and you tack on the depreciation expense at the end of that, that takes you in the negative territory, even though your property is probably worth more than it was twelve months ago.
Because of that, you're actually paying less in taxes, even though your property has positive cash flow. One of the most amazing things about real estate that you want to keep in mind is that your taxes that you're going to pay are probably going to go down. There are exceptions to this. There are some high net worth or high income individuals who have that ability to deduct that phased out once you get up to a certain income limit, so talk to your accountant about that, but for the vast majority of our clients, you're getting a tax benefit from owning this rental property even though you're getting free cash flow coming into your pocket.
So that's very important to remember that when you sell that property, you may be getting rid of the "hassles" of owning a rental property ... which by the way, we're taking most of those "hassles" on for you by managing it ... even if you're getting rid of these so-called hassles, you're losing your tax-advantage. So, you're going to actually lose money the following year and the year after that and so on in perpetuity. You're just losing all of that advantage that you would've had, so it's very important to keep that in mind.
The third thing I want to say is rent is not the same as property values. It's important to remember how this works. I'm gonna put a chart up on the screen here so you can take a look at this. Property values are all over the place. They jump all around over the years. That never stops. Bubbles develop and then pop ... we all know how that works with real estate, we saw it in 2008. But rental prices do not do that. The beauty of rental prices is they pretty much always go up every single year, and over the long term you don't see big bubbles and big recessions. It doesn't matter what the economy is doing, rental prices are almost always ... in fact, if you look at the chart here, over the past forty years or so, there's never been a time when rental prices have gone down. They always go up by some amount. Sometimes it's more than others, in some cities it's more than others, but the rental prices keep climbing.
The reason for that is simple. Housing is really slow to build, so the population is constantly growing, builders usually can't keep up with that. When they do keep up with it, that's all they're managing to do is keep up with it, they're never ahead of the curve. Because of that, there's always a growing demand for real estate. Inflation is always going up, also economic growth is going up. So, rental prices don't stop climbing, those keep going up. That's something you always have an advantage of. Whatever your cash flow is today, five years from now it's almost certainly going to be higher. Ten years from now, it's going to be a lot higher. Every year that goes by, you're getting more and more benefits from owning that rental property, because that rent is going to keep climbing.
For those of you who've been with us for a few years, you've seen it. Every single year, we're raising that rent. It might just be three percent, but take out your calculators and start compounding 3%, and see where that winds up in ten years. It's a big difference what you'll find there as far as what that's going to mean to cash coming into your pocket. So, that's a very important thing to think about. Rent is not the same as property values, remember that. Property values rise and fall, it can be a rollercoaster. Rent does not do that.
The other thing is even though housing prices are constantly going up and down, over the long haul, looking at long periods of time ... housing doesn't go down. Other investments ... look at the NASDAQ, it was down for a very long time, and even today it's just barely back where it was twenty years ago. So, that's a big difference from real estate. When we had our bubble burst in 2008, it was only about eight years before we were back to where we were at that point, which was the highest point it had ever been in history, and now we're above that. That's how real estate always does. Eventually, it gets back up even after there's a big bubble that bursts, because of course, they're not making anymore land. There's only so much to go around here on planet Earth. Over time, that value is always going to go up ... there will be ups and downs, unlike rent, property values will go up and down over time ... but the upward trajectory is always there. It's always going to be worth more ten years, fifteen, twenty years from now than it is at this point. It's a very safe investment.
The other thing is ... one of the great things about real estate is because you're paying it down over that period of time really slowly, because you can get that great, low interest rate on mortgages, your property is probably going to be paid off right around the time you start to retire. For those of you who are my age, or even younger, by the time you retire, that property's going to be completely paid off. So about the time you're deciding to stop working, all of a sudden you're going to have this big boost in cash flow. You bought this house when you were, say, thirty-five years old and you decide to retire when you're sixty-five, all of a sudden the property that you were cashflowing $500 on, let's say, now all of a sudden that mortgage payment is gone, and you've got that huge amount of cash flow coming in right as you're about to retire.
It times very well for that if you're starting to buy properties in your twenties, thirties and even forties so you can have that property paid off when you're going to need that income the most, especially for those who might worry that social security's not going to be around when they start to reach that age.
So obviously, our opinion is it's not a great idea to sell your rental property. I know a lot of people are starting to look at the prices of houses right now and they're saying, "Oh look, I can get a little bit more than I paid for it twelve, fifteen years ago before the bubble burst!" That's not really the best way to look at it. That's just opportunistic selling, that's not really looking at the financial picture. Take a look at your finances. See what sort of advantage you're getting from owning that rental property. See what sort of advantages you're going to get in the years ahead. It's almost certainly not a good idea to sell rental property, unless the reason you're selling it is to use the proceeds to buy more rental property.
That might be a different situation, but just to sell it and get out, you're going to pay tax on that, you're going to lose a lot of any sort of profits you get out of it. You're going to pay real estate commissions on it. You're going to lose a lot of the benefits that you think you're getting out of it, plus you're losing all of those long-term benefits that we just talked about of owning rental property, so it's probably not a good idea for you to do that. Conversely, though, it's almost certainly a good idea for you to buy more rental property. All of us have 401k's, or most of us do, where we're putting money into stocks month after month just coming out of our check. Maybe your employer's contributing some of it. That's a great investment, everybody should invest in the stock market in their retirement account. It makes a lot of sense over the long haul. But as Warren Buffet and every other great investor will tell you, always diversify. You never want to have all of your eggs in one basket.
If you had started to retire right around 2002 or 2008, or going back further than that ... there's always a bubble that bursts in the stock market, and usually when a stock market bubble bursts, it is a big drop. So, when that happens, if you happened to retire around that time, the value of your investments has taken a huge, huge hit. That doesn't happen in real estate. You can have small reductions, but you're not going to lose half of the value of your property usually over night as you can in stocks. By diversifying into real estate, you get a good cushion there that's going to help you from losing so much of your investment all at one time. A lot of times when stocks are doing bad, real estate is doing well. That's something that helps to smooth out those ups and downs also, so it's a good thing to diversify.
So, our advice to you is buy more investment real estate. Whether you're having us manage it, or even if you're buying it in another state where we can't manage it for you, it's still a good idea for you to buy that rental property. So, if you want to do that, we want to help you out. If you want to do that here in Georgia or Florida where we're licensed, we're happy to help you with that. We can actually set up automatic alerts that you can get by e-mail. You can set up whatever sort of criteria you're looking for. Say you want to look for houses that are listed for less than $75,000 in certain counties that have at least three bedrooms or whatever criteria you're looking for, we can set those up for you. It'll automatically screen all of the listings in the e-mail list and send you an e-mail every week showing you what properties are available, then all you have you have to do is tell us, "Hey, I want to make an offer on this house. Can you take care of that for me?" We're happy to do that for you, and then we can manage it for you after that.
It makes it really easy. It's turnkey for you. You can have us handle the purchase, and if you have to do any work to the property we can get that handled with our vendors, and then we can get it quickly rented out and get you positive cash flow on that new property you own. It makes it really easy for you, you can be in Okinawa on the other side of the planet and tell us, "Hey, I saw this property in the e-mail you sent me. I like the way it looks. Can you go out and take a look at it for me and tell me if I should buy this? If so, let's move forward and take care of all of it for me." Just a turnkey investment. We can take care of all of that for you. Just let us know if you want to set up something like that, just send us the criteria at email@example.com. One of our real estate agents can set that up for you. We can only do this, like I said, in Georgia and Florida ... that's where we're licensed ... but let us know and we can set that up to where you get those automatic e-mail alerts and we can start helping you buy more rental property.
If you're looking at other states also, there's some other states that have some really good deals out there. Ohio, Arkansas ... there's some really good deals out there to be had, even in this up market. If you want to do that, just make sure you find yourself a good broker that does not only sales, you don't just want to talk to a sales agent, you want to work with a property management company when you're buying rental property. The reason for that is a sales agent, they know about buying and selling properties for homeowners ... people who are going to move in and actually live there. That is a whole different world than buying properties that are specifically geared to be rental properties. A house that could be a wonderful house for you to live in is frequently not the best house for an investment to rent out, so you want to have somebody who actually specializes in that.
If you have a state that you want to invest in that's not one of the states that we work in, let us know ... we can probably find you a good broker that's a property manager that specializes in that sort of thing in that state, and we can help you get connected with somebody that can help you do that. But of course, we are more than happy to help you in Georgia and Florida. Georgia, especially south of Atlanta, is still a great market. You can find a lot of houses that are great rental properties for very reasonable prices. So, just let us know if you want to do that.
There's also another option for those of you who don't really like owning rental property, but you still want to have some exposure in your investment portfolio to real estate ... if you'd like, we're happy to borrow money from you so we can buy houses in our portfolio. We'll give you great interest rates, so you can just give us a fixed term loan of a fixed interest rate, and the longer the term you'll give us on the loan, the higher we'll pay as an interest rate on that. You could get anywhere from a 5 to 10% interest rate on your money, and it'll be secured by a property that we purchase into our portfolio, so you can get that guaranteed return paid to you every month. Because it's secured by the property, it's pretty much risk-free. Nothing's ever completely risk-free, but it's as close as you can get because it's secured by that property that will already have equity in it because we'll be purchasing these houses with cash. That's how we typically purchase them when we put them in our own portfolio.
We'll put money down, and you would just cover 80%, 70%, 60%, whatever it is of the remainder, and we would just pay you interest on that. So, it's a great way for you to get a decent safe and steady return on your money without actually having to purchase the property yourself. If that interests you, just let us know. We're always looking to pick up more properties in our own portfolio, so we'd love to pick up more than we can with just our own cash ... obviously we're limited to how many we can purchase each year with just our own cash, so if we can get loans from our clients, then that would certainly help us to be able to purchase more property also and you could get a good return on the money.
So, lots of different ways you can invest in real estate and try to diversify your portfolio and get some safe, better returns than you can get on other safe investments like bonds and savings accounts, so feel free to talk to us about that. Send us an email at firstname.lastname@example.org. We'll be happy to help you out with anything related to real estate investments, and we'll talk to you later.