My strategy for investing is not dependent on my properties appreciating. Do I want them to appreciate? Yes! It allows me to refinance easier and possibly pull cash out to buy more properties if I need it. However, I do not need my rental properties to appreciate in order to make money and get good returns.
I am making over 24% cash on cash return on my rentals. I detail exactly how I do this in my complete guide to purchasing long-term rental properties, which includes information on mortgages, buying properties, strategies and detailed numbers.
One of the biggest mistakes I see investors make is buying rental properties with little or no cash flow in hopes they will appreciate in value. This is not really investing, this is speculating that the market will increase in value. I never buy a property with my only profit potential being appreciation.
I buy a property under market value or improve/repair a property to add value. The most important thing I do, is I always buy a property with positive cash flow, bringing in income as soon as I rent it. If values go down it doesn’t matter, because I am making money every month and I don’t need to sell. In fact, I don’t want to sell, because that property is making me money every month.
Rental property expenses
The biggest problem with buying a home with negative cash flow, is investors almost always underestimate their expenses. The fact they are buying a property with negative cash flow, means they are usually stretching their criteria in order to make a deal. Repairs and expenses almost always exceed expectations, unless you assume there will be many unknown costs. It is always best to error on the side of caution, when calculating expenses, especially if you are new to investing.
Many beginning investors do not account for the unknown, because they really want to make a deal work. It is very easy to justify numbers that don’t quite make sense when you are a beginner investor looking for your first deal. I did this all the time when I first started, using minimum repair and expense numbers, not maximum numbers. When this happens, your emotions are ruling the deal, not logic. If you really want to make a deal work and you fudge the numbers to get everything to line up correctly, you are asking for trouble.
Money coming in, not out
Most investors who buy properties with no cash flow, get tired of writing checks very quickly. They want out and most likely, they want out quickly. In most cases prices have not appreciated enough to make any money. The investors only choice, is to continue to dump cash into the property every month or to sell at a loss. After the closing costs and paying commissions to Real Estate agents, the investor loses a big hunk of change. This happened to many investors when the Real Estate bubble burst a few years ago. They were investing based purely off anticipated appreciation, without regards to cash flow or long-term scenarios. When the bubble burst they lost everything. Right now many people feel we are in a similar bubble, although I am not so sure.
The simple way to avoid shelling out cash every month on a rental, is to invest in a home that cash flows. If values go down, than rents may go down as well, but unless your margins are really tight, you will still cash flow and you won’t have to sell. The easiest way to lose money in Real Estate, is when you have to sell your property in a buyers market and you need to sell it quick. The only buyer may be an investor like myself looking for a great deal!
Predicting the market
Even though prices are going up right now, no one can predict what they will do in the future. There are too many economic unknowns to know what the housing market will do. Interest rates could rise, the US economy could tank, the world economy could tank. Base you purchase off of cash flow and these factors may affect your bottom line, but they won’t bury you.