Real estate can be the best, safest, and fastest route to financial freedom as compared to other methods by which to create wealth. More specifically, rental properties allow you to borrow money from banks or other lenders to increase your potential return: this mechanism is known as leverage. In other words, you do not need to have 100% of the purchase price of a property available to be able to purchase it. The investor simply needs to provide a small down payment, and a lender provides the remaining balance of the purchase price of the property, then the investor pays the lender a small amount each month until the loan is paid off, using the rent they receive from their tenants.
What's more, the great thing about rental properties is that demand will never run out, despite market fluctuations. People always need a place to live, especially in a culture that increasingly values mobility, meaning that the demand for rental properties will only continue to grow over time.
The main sources of wealth generation from rental properties are:
- Appreciation, which is an extraordinary increase in the value of an asset: a house worth $100,000 in 1990 could end up being worth $500,000 today, thanks to appreciation. There are two types of appreciation: natural and forced. Natural appreciation is the tendency for prices to rise over time due to several factors, including inflation and scarcity. Forced appreciation comes from improving a property to increase its value, for example, transforming a two-bedroom home into a three-bedroom home or adding a second bathroom. There is no denying the role that appreciation plays in investors’ lives, but the risk associated with relying on appreciation alone to make a profit is just as significant. Therefore, appreciation should be considered as icing on the cake, or an added bonus, not the basis upon which an investment is made. Treat appreciation for what it is: a possible reward for a well-made investment.
- Cash flow, which in the rental property industry is the income left over after paying for expenses incurred by the property, such as mortgages, taxes, insurance, vacant rent, repairs, capital expenditures, and utilities. To predict your cash flow, you need to understand your income and expenses, and this is where most people get confused. While it is impossible to predict the cash flow of an investment with 100% certainty, you can get a fairly close estimate by looking at both historical data and industry averages. Cash flow is perhaps the most important wealth generator for rental property investors. Appreciation is a plus, but most investors are looking for a solid and stable return on investment, which can only be achieved through steady cash flow. Buy rental properties that will provide you with instant cash flow, or as quickly as possible.
- Loan repayments: you can automate some of your wealth creation by simply taking out a loan on your rental property, and using your tenants' income to pay off that loan each month. We said that a property's cash flow is its total income minus its total expenses. One of these expenses are the mortgage repayments. You can create wealth simply by using your tenants' rental income to pay off the mortgage on your property. Of course, this particular wealth generator does not apply if you make the purchase in cash, because in that case there is no repayment loan to pay off. However, without a loan, you can keep a higher percentage of the property's rental income, so your cash flow would likely be greater.
- Tax savings: in some countries, particularly the United States, the government rewards and encourages real estate investors through favourable tax treatment. This approach is linked to the fact that the population is increasingly rent-oriented and real estate investors guarantee economic stability. Of course, for an investor this doesn't mean buying any old property, just for a tax break. Tax benefits will never make a bad deal a good deal, but they can make a good deal even more attractive.
Building wealth from rental properties is not something that happens overnight, but requires consistent long-term action. To have lasting success in the rental property market, you will need to make sure you define the right plan for achieving financial freedom through rental properties. What is your ultimate goal? Where are you heading? What kind of strategy do you want to use? What will you not do? (For example: I will not buy condominiums, commercial properties, etc.) What type of property do you want to buy? How often will you buy property? How will you finance everything? The goal of a plan is to make you think, learn, and strategise.
You'll also need to use the right metrics. Rental properties are different from most other asset classes because they need to be continuously maintained and managed. When it comes to real estate, one metric to keep track of is the performance of your property. How was your cash flow last month? What kind of increase have you seen in expenses in the previous twelve months? What has your property’s appreciation rate been like over the past decade?
You also need to keep in mind that there are risks involved in every kind of investment. If you want to avoid wasting all the hard work you are putting in, you need to understand that risk is a powerful and yet dangerous tool, so proceed with caution, never stop learning, and always do the numbers for any property you purchase.
How much money should you have to get started? The simple answer is: enough money to cover your down payment and maintain healthy reserves. When you own a rental property and use all the profits from that investment to live off, you severely damage your capacity to generate wealth through compound interest. By reinvesting your cash flow into your rental business, you will be able to earn additional interest on previous interest.
