The S&P 500 index appreciates at double the rate of our homes (10% vs. 5%).  That’s not new, it’s been that way for 50 years. So, why invest in rental property?

Because you can get returns far above 10% if you know how to exploit its advantages. I’ll explain with a personal example.

I bought a property in 2016 for $800,000. I didn’t pay $800,000. I paid $200,000. I got a mortgage on the rest. The mortgage created leverage which turned the property’s  5% appreciation into a 38% return on my investment.

Here’s how that worked: The first year my property appreciated $40,000 (5%). That’s a 20% return on a $200,000 investment! (40¸200=20%)

But wait, don’t I have to reduce the $40,000 by my mortgage interest and other expenses? No. The rental income covered it. In fact, this year’s net rental income is $20,500. If I add that to this year’s appreciation of $55,000 (5%), my return is 38%.

The property has appreciated at about 5% for 8 years and is worth $1,200,000. The cash flow has paid down the mortgage to $500,000. My equity is $700,000, up from $200,000.

But my equity doesn’t do me much good sitting there. If I sell the property, I’ll have $700,000 to invest in one or more rental properties. If I put down 25%, I can buy one or more properties worth a total of $2,800,000. (700¸.25=2800) At 5%, the annual appreciation on them would be $140,000. That’s a 70% annual return on my $200,000, not including rental income.   

But wait, if I sell, don’t I have to pay tax on the gain. No, not with rental property. Section 1031 of the Internal Revenue Code allows you to re-invest the proceeds of rental property into other rental property(s), tax free!

I know, it sounds amazing. But I’ve done all this before. In fact, in this example, my $200,000 investment came from a $60,000 investment in another property in 2007.

By the way, rents have risen at the rate of 4.25% for the last 50 years. The odds are they’ll keep going up. As a landlord your biggest expense is mortgage interest, and that goes down every year! Be Patient!