Investing in rentals is a lot like attending college. College affects many aspects of your life: what kind of job you get, where you live, and even what kind of car you drive. Just as college attendance has long-term impacts on your life, so do the decisions on a rental property. In college you pick a major, take classes, study, finals, and graduate. You must do all these steps to finally walk on stage. When done well, you graduate with honors.
Purchasing rentals has a process as well, such as save, learn, pick a goal, find strategies, research rentals, purchase, hold, and sell. In college, you earn a grade to show how well you are doing; however, with rentals, your grade is the return on investment. The four areas of revenue or you could say your “classes”, are cash flow, appreciation, equity, and taxes. A property that generates revenue in all 4 areas will receive an “A” rated return. The majority of the properties produce revenue on 2-3 areas thus earning a “B”. A foreclosure is equivalent to a failing grade.
Cashflow is the most well-known and popular revenue source. It is a bit more exciting to discuss because it impacts daily living. You either have positive or negative revenue this month, which either adds or reduces your monthly finances. Investors calculate cash flow based on income minus expenses equaling the net, or net then minus taxes and interest, or net minus taxes, interest, and reserves.
Equity is frequently forgotten and not calculated because the benefit won’t be seen for years. The majority of the rental properties are purchased with a loan and a 25% or greater down payment. The monthly mortgage payment is then paid down from rent proceeds rather than the investor’s personal income. Over time, the mortgage is paid down causing a gap between the purchased price and the balance, thus causing equity in the property all while being paid by someone else.
Appreciation is market-driven and impacts the value over time. Mathematically it is the difference between the purchase price to today’s market price. Every location has different market cycles causing the generated revenue amounts to vary. South Anchorage is a highly desired area and tends to have a steady increase in property and rent values. Most investors base their calculations on the 10-year average of property values.
Taxes are difficult to explain due to its complexity. Consulting with a variety of experts is a necessity; I.E. CPA, Financial, Lawyers, and etc before calculating the benefit. The best way to explain is by how one local investor used taxes to their advantage. This person is a high-income earner and used the purchase of a negative cash flow property in need of some repairs to reduce taxes for several years. This was done because the tax break was larger than the monthly loss of the rental. This investor generated revenue from taxes, equity, and appreciation.
Like college, every investor has a different path that has long-term impacts.