Consider the following scenario:
You decide to buy a rental home and officially enter the Wonderful World of Landlording.
Five years later, after reviewing all of your financial information, you realize that you essentially broke even - from a cashflow standpoint - on the investment.
Meaning, while the investment didn’t put any additional cash into your pocket at the end of five years, you weren’t required to put any additional cash into the investment either. So, basically, your rents covered your expenses.
Is this a bad thing?
Ideally, single family homes WILL produce cashflow. But a consistent theme we’ve discussed in our blog, and one we stress with our customers, is that single family investments can be a grind.
Some years are better than others.
In fact, some years can be downright disastrous, particularly if you own just one rental property and that one rental property needs a new roof, or a new HVAC system, or suffers an eviction.
We’ve always been of the opinion that real estate is a long-term proposition and should be evaluated as such.
Assumptions on Breaking Even
Cashflow Model: When we say “break even” we are talking about cashflow, not your overall ROI, which can’t even be measured until after you sell the property. Or, not what your tax return shows after accounting for depreciation. There’s big difference.
Mortgage is in Place: Break even cashflow isn’t necessarily a bad thing assuming that you have a mortgage on the property. If you paid cash for your investment and experienced break even cashflow after 5 years, that’s an entirely different story.
Why Break Even Cashflow Is OK
So, assuming you do break even after 5 years, you might wonder… “How can this be a good thing? I got into this investment to make money, not to break even.”
Well, even though you broke even, you will have reduced your taxable income and, likely, added some wealth to your personal financial statement during that 5-year period.
So, hardly a waste of time.
As you know, or as you should know, investment properties come with exceptional tax benefits. You can deduct almost all expenses related to the investment (including property taxes, insurance, repairs, etc.) and you can also claim depreciation. All of this will reduce your personal tax liability.
So, depending on your situation, you’ll either get a larger tax return, or you’ll have to pay less income taxes each year, purely as a result of owning rental real estate.
In addition, using the 5-year scenario we discussed earlier, your Tenant essentially paid your mortgage for you each month. So, if you get a 20-year mortgage, your Tenant, at the end of those 5 years, has reduced your loan by thousands and thousands of dollars, which directly impacts your personal wealth.
Finally, your home SHOULD be worth more at the end of those five years, assuming you bought in a solid area. This is a key point here. I think many investors make a mistake of buying in very low-to-no appreciation areas simply because they offer better cashflow. If you take that risk and cashflow doesn’t work out, you also miss out on one of real estate’s best benefits, which is appreciation.
Never Buy a Home That’s Guaranteed Break Even or Worse Cashflow
One final note… don’t set yourself up to fail.
Before you buy a home, the cashflow models you run should always show a nice chunk of positive cashflow each year. And, if everything goes extremely well, maybe those models will translate into reality.
However, it makes no sense - none at all - to purchase an investment that will produce negative cashflow. It’s no different than buying a boat with a small leak.
As always, if you have any questions about cash flow or Property Management in general, please don't hesitate to contact us!