Many people worry about values and appreciation when purchasing a rental property. I consider appreciation when buying a property, but it is not my primary concern. My main concern is how much cash flow I make compared to how much cash I have in a property.
I am making at least 24% cash on cash return on all of my rental properties. With this kind of return I don’t need my properties to appreciate to come out way ahead. However, my properties have been appreciating in the last two years and I consider that a bonus. Please check out my complete guide to investing in long term rental properties to see detailed numbers, how I find properties and how I finance properties.
On my properties I try to cash flow at least $500 a month. That leaves me plenty of room for rents to decrease or for unforseen repairs. I plan to hold these properties long-term so the only reason to worry about appreciation is if I need to refinance. Even then, I think of refinancing my rentals and taking out cash as a bonus, not a critical part of my business model. Here are a few things to help protect me from a down market and decreasing values.
1. I buy properties with a 20% down payment. That builds in equity as soon as I sign the paperwork and should allow me to sell the home even if prices go down. Yes I will lose money if I have to sell right away, especially after factoring commissions for agents, title insurance, recording fees and the decreased price, but I can still sell if needed.
2. I buy properties that are below market value and add value through repairs or improvements. I only purchase properties that are at least 15% below market value. I also buy properties I can add value to by adding a bedroom or making repairs. When the property is ready to rent my mortgage is usually 60% or less of the value of the home. This leaves me plenty of room to sell if needed.
3. I don’t plant to sell! I plan to collect rent every month, continue to build my wealth and pay down my mortgages. If the market goes down and I don’t want to sell it does not affect me at all. Even if rents go down, I have enough room in between my mortgage and rents to absorb a rent decrease and still cash flow. Historically values have always gone up over time. If I can wait out a drop in the market eventually prices will go back up again.
As long as you don’t have to sell your rental property during a downturn in the market won’t hurt you. If you are buying your first property and cash is really tight, maybe you should save up a little more. Remember, repairs always cost a little more than you think and the house might be vacant a little longer than you think. Even if you really want to jump in the game as soon as you have just enough money follow the first two tips above and if something happens where you have to sell you should be fine. Here is an idea of how much you will need for a rental property and how you can get into a rental property with less cash if you are just starting out.