Before trying to select a
property, you need to define your goal or goals. That is, what do you want to
accomplish and over what period of time.
The same criteria that is used in any sound investment strategy or financial plan should be used in the rental property business. The basic goals or reasons for investing are usually among the following:
- Monthly cash flow
- Maximum cash flow is realized from minimum leverage. That is, you will have the most cash flow from a free-and-clear property. Cash flow will decrease with increasing leverage, and leverage using low or no down payment often results in a negative cash flow.
- Long term appreciation
- Maximum return from appreciation comes from maximum leverage. That is, the fewer of your own dollars you have invested in the property, the greater percentage each dollar of appreciation represents relative to your investment. However, if leverage produces negative cash flow, the accumulated negative cash flow must be deducted from appreciation when analyzing the overall term of investment and the result can actually be a net investment loss.
- Tax shelter
- Maximum tax shelter is also realized from maximum leverage. Not only does higher leverage allow ownership of larger or more properties, providing more depreciation, but it also results in greater interest expense and less net income. Again, excessive negative cash flow can affect the result.
- Resale for quick profit
- Unless a Section 1031 tax deferred exchange is utilized, short holding periods result in taxation at ordinary income rates rather than at the lower long-term capital gain rate. The minimum holding period for the minimum tax rate is currently 18 months. Sometimes the dynamics of the investment results in greater after-tax annual return in spite of the higher tax rate because the gain from rehab is significantly greater than near-future appreciation.
- Operating
- It is very important to understand that owning and operating rental property is not just an investment, it is a business. Before you purchase any property you should have a plan for how you intend to manage it. You can learn to do it yourself as a member of LandlordAmerica and spending the necessary time to study our e-courses and other information on our Web site. You can also hire a professional property manager to operate you business for you, but you should still have an understanding of the basics so that you know your manager is doing his job right.
- Summary
- Obviously, you can have more than one goal at a time so long as they aren't mutually exclusive. You can have monthly cash flow and long-term appreciation and tax shelter. In fact, structuring the purchase for all three will usually result in a safer and more flexible investment. You cannot have long-term appreciation if resale for quick profit is your goal, but it is possible to have cash flow and/or tax shelter from property that is purchased for resale for a quick profit..
- If you have decided that you just want to get rich quick, with no money
down, like they do (or claim to) on TV, visit
our Web pages on that subject first, then come back here to learn the
real world basics.
