Most investors know that real estate is an important part of any balanced investment portfolio. For some this is accomplished via a real estate investment trust or some sort of other exchange traded vehicle that owns and possibly manages a real estate portfolio. Some investors, on the other hand, actually have a direct interest in some sort of property which they rent out. I’d like to take a moment to discuss why purchasing real estate directly could be a wise options.
For the sake of this post, we’ll assume that the investor is purchasing a single family rental home in a good neighborhood of a mid-sized Midwestern city. The investor doesn’t necessarily have to live in the town as management costs will be included in my figures.
In Missouri, a solid rental home that’s not in a war zone can be purchased for $70,000 or so. Generally it could be rented out for about 1% of the purchase price or a bit more, we’ll go with $750 per month.
Assuming a down payment of $14,000, this leaves a mortgage balance of $56,000. There will be closing costs associated with the purchase and they could run around $2000. With taxes of around 1.25% and no PMI, the monthly mortgage payment is going to run about $436. Monthly management of a single family home will run about $50 and maintenance shouldn’t be too high–probably around $50 per month.
Net cash flow is looking like approximately $3,768 per year. While it would be nice if the home was rented out every month for the entire year, it’s not that likely. We’ll take out one month for a new annual cash flow of just at $3,000.
Time for the exciting part! Let’s calculate the return on investment for this house. It’s pretty simple, ROI is defined as “what you get over what you give” so in this case it’s $3,000 divided by $16,000 which gives us a gross return of 18.75%. It’s important to note the word gross. This return isn’t perfectly accurate, it’s pretax and there’s a lot of factors that could mess it up!
There are also a lot of factors that could actually RAISE returns. Many investors can realize a significant tax benefit by owning rental properties and this could add a few percentage points to returns. There’s also principal pay down to consider, tenants are building equity in a rental home for the owner, so this is added into the return.
The bottom line is rental home investing is not for everyone but it can produce some really attractive returns. It wouldn’t be ridiculous to expect a 15% net return for single family homes. Over time, that kind of return can turn into some serious cheddar! Do your research and if the numbers work, the commitment might make sense for you.
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This article was researched and written by the professionals at Mortgage Loan Place, the online leader in free info on FHA home loans, mobile home loans, and construction loans.
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