If you own investment real estate, you have a triple chance to make a profit:
1. You can collect monthly rent from tenants.
2. You can sell the house if it gains value.
3. You can refinance the house if it has appreciated, pulling out cash from a larger loan, tax-free.
Judging by options 2 and 3, your profit potential will be enhanced if you use a mortgage to buy a home that gains value.
The term “positive cash flow” is critical for real estate investors: it means that the rent you collect from tenants exceeds all of your out-of-pocket expenses, including insurance, maintenance, and taxes. This usually happens when the investor makes a large down payment and has relatively low mortgage costs. Most investors prefer to maximize leverage with a large mortgage so it may take years for rental increases to grow, outstripping fixed mortgage interest costs.
Some people who buy investment property think they’ll enjoy positive cash flow right away. That probably won’t be the case unless you’re making a very large down payment. Often, you’ll go three to five years before cash flow turns positive.
Investors also need to have a reasonable idea of how much rent they’ll be able to charge. To set the rate properly, you should do your homework, checking out how much comparable properties rent for, or you can work with a property management firm.
Don’t forget to calculate mortgage interest. Say you buy a $200,000 house with a 70 percent ($140,000) loan. If you borrow $140,000 at 8 percent, that is $11,200 a year, or $933 a month, just for interest. You’d have to rent the house for more than that–enough to cover all your other expenses–in order to obtain positive cash flow.
Thus, before you borrow money to buy rental property, crunch the numbers and scout the area to see how much rent you’ll be able to charge.