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Lesson 1
Investment Goals
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 RHOL 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.
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