Long Term Approach Works Best With Real Estate Investing
To many, real estate investments have proven to be almost as "scary" as stock market investing. With property values still quite low following the housing collapse that began back in 2007 and no certainty about whether the "bottom" has been reached, it makes sense why investors remain shy about this segment. However, with a long-term approach, an investment property can easily make sense if you look at it as but one component of your investment portfolio.
No Longer a Short-Term Game
Where income properties remain risky is when they are purchased for speculative or short-term purposes. In the past, a host of "gurus" advocated leveraging their assets in order to purchase income properties and using their equity to buy more and more. With more reasonable growth rates (if any) as well as strict lending criteria, this type of strategy is no longer available to investors. As such, only a long-term approach makes sense.
Today's Risks With Income Properties
In terms of risks in today's sensitive market conditions, income properties face several risks. Probably the biggest one is whether current rental rates (let alone future rental rates) will meet expenses. This seems to be more prevalent today than ever before. However, when investors take a long-term approach with their income properties, shortfalls between rental income and expenses is virtually meaningless. Here is why.
Suppose an investor purchases a four-plex for $400,000 and is able to finance a full 100% of that purchase price. Each unit generates $750 in income, or $3,000 per month but for some reason or other, the expenses (mortgage plus taxes and incidentals) amount to $3,250 for the month. The shortfall of $250 means the investor must inject $3,000 every year into their project ($250 X 12 months). However, over a 30-year period, that $400,000 property is completely paid off. While the investor had to inject $90,000 into the property, even if property values remain stagnant, that $90,000 would result in a $400,000 property being free and clear. That is more than triple the actual invested capital. The investor can either sell their $90,000 investment for $400,000 minus fees or can continue to generate $750 per unit, or $3,000 per month (again assuming that rents have not increased over 30 years). The net return on the investor's $90,000 investment is 40% Net per year. Wow, what a great return.
Growth or Income - The Choice Is Yours
Whether an income property serves a growth or income function is entirely up to the investor. Growth comes in the form of a minimal (if any) investment that enhances the investor's equity position as the mortgage is paid down or off through rental income; Income comes from the rents generated once the property is paid down considerably or paid off entirely, ideally by the time the investor retires. In that sense, long-term real estate investing really does make sense for most investors.