This list is not exhaustive, but let’s talk about 5 key principles that make rental property investing a unique investment.
The Principle of Leverage
The Greek mathematician Archimedes famously said, “Give me a place to stand, and a lever long enough, and I will move the world.” Let’s start with possibly the most powerful benefit of real estate investing: leverage. Just as using a lever can exponentially increase your strength when moving an object, using leverage can exponentially increase your returns when investing in real estate.
Unlike many other investment tools, banks will often loan you money to purchase real estate. Leverage is created when you use that borrowed money to acquire property that you would not have been able to acquire with your own money.
The Principle of Building Equity
When you own a rental property, an interesting thing begins to happen each month. You begin to look forward to making the mortgage payment. Why? Because your rental income is paying down your mortgage each month. With each passing month, the amount that goes toward principal increases and the amount toward interest decreases. This has a compounding wealth building effect over time, especially if you reinvest your extra rental income each month to make additional principal payments, or if you use it to buy more rental properties.
The Principle of Control
When you own a stock in a company, your ownership stake doesn’t mean that you get to help decide the direction of the company. You have no control over the decisions made by the Board or the executives. In fact, one executive can make one bad decision or moral failure and it can impact your net worth. With a rental property, you have the control. For better or for worse, you decide where to buy, when to buy, which repairs to make, when to rent, when to sell.
Control can be a turn off for some who don’t want the pressure of making big decisions, but for others it is one of the most attractive principles of real estate investing.
The Principle of Options
Closely related to control, rental property owners have the luxury of making decisions based on their individual goals, life circumstances, and current market trends. At any point a property owner can decide to:
- Access the equity by selling the property
- Keep holding the property and continue to receive income and build equity
- Adjust to the market by raising or lowering the rent
- Pay for a big expense such as a wedding or college by refinancing the property
- Increase the value of the property by making improvements
- Engage in a tax-deferred 1031 exchange
Your real estate agent, tax advisor, and financial advisor can help you evaluate each of these options.
The Principle of Inflation
There are many investment vehicles that historically outpace inflation, but you could actually argue that inflation works in favor of the rental property owner.
Let’s unpack this a little. Rental rates tend to somewhat mirror the inflation rate, whereas your principal and interest payments are locked in. Theoretically some expenses such as taxes, insurance, repairs, capital expenses will rise with inflation, but over the 10-30 years that you are paying off your mortgage, your margin between rent received and mortgage paid will continue to grow and grow. Therefore your return on investment will increase year over year. The principal of inflation works in your favor either way, but it is amplified when combined with the principle of leverage.
The Icing on the Cake: Appreciation
Property values tend to rise over time, but as we all remember from the late 2000’s, appreciation is not guaranteed. But the good news for a rental property owner is that the goal isn’t to time the market. The goal is to buy a cash flowing property and hold it for many, many years. Having established that, many rental property investors do enjoy the icing on the cake of selling a property for significantly more than they paid for it.