The Money Mustache Community
Learning, Sharing, and Teaching => Real Estate and Landlording => Topic started by: missionalan on July 18, 2016, 02:45:01 PM
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This is probably a really stupid newbie question, but hoping someone with rental real estate knowledge can help me with this as I'm looking to get into rental real estate in the future as a way to diversify.
If I have a single family home that's worth 150k. It brings in 12% gross income per year. After everything is taken out, I annually net 6%. How is the base price reduction of the home figured into the calculation? Because at the end of loan term, I'll still be making 6% and have a 150k property.
The reason I phrase it this way is because I hear a lot of people talking about passive income but no one talks about actually owning the property, which I would think would be part of the calculation.
Thanks for humoring me.
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When you say 12% gross and 6% net, I assume you mean 18k and 9k respectively?
When you say you'll still be making 6% at the end of the loan term, why wouldn't that be higher since the loan is paid off?
A rental house is an illiquid asset. When it's paid off, it creates a higher income but the equity is locked up.
What do you want to know about "owning the property"?
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The reason I phrase it this way is because I hear a lot of people talking about passive income but no one talks about actually owning the property, which I would think would be part of the calculation.
What is there to talk about? What calculation?
Be more specific. :)
If you mean calculation for FIRE, well cash flow is the important part. You can't pay bills off equity, unless you tap it somehow, or sell.
If you're talking about appreciation adding to your net worth, well, that's great, but unless it comes with increased rents, or you sell, again, it doesn't matter.
In general though, it's not mentioned because it doesn't matter, as it's mostly cancelled out due to inflation. Historically, house prices and rents rise (roughly) with inflation.
So you may get $X in cash flow, and it's worth $Y. X and Y rise over time due to inflation, but stay flat in real dollars. So in 20 years, you're still getting $X in rent in real dollars, and it's still worth $Y in value (even if both of those numbers have doubled in nominal dollars).
So most of us count on that rise to cancel out inflation, and the house value itself doesn't matter--it just sits there, preserving its value, and providing the cash flow.
You can't count the value of the house itself in terms of a spendable portfolio AND count the cash flow towards your spending, that would double count it and get the numbers wrong.
Does that make sense?
If you meant some other calculation...please clarify what you're asking.
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If you're getting a loan on the property, when the loan expense goes away you'll have greater cash flow. I think most people don't talk about it because it doesn't impact how the property will cash flow today.
I guess if you're trying to predict what your cash flow will be at the end of the loan, then just add the loan expenses you have today to the cash flow you have today. As noted, rising rents should balance out inflation.
So the fact that you own it doesn't matter, but the reduced expense will have an impact.
Is that what you were trying to ask about?
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If you're getting a loan on the property, when the loan expense goes away you'll have greater cash flow. I think most people don't talk about it because it doesn't impact how the property will cash flow today.
Plus, if you have a 30 year loan, inflation will have eaten away so much of the payment (and the rents will have increased due to that) that the sudden extra cash you get from it being paid off is a lot smaller in real dollars than you'd think (just a quarter of what it was, in real terms, with just 4-5% inflation).
It can be significant if you bought a property with a huge mortgage that didn't cash flow at all, but for many of us, the mortgage is already such a small part of the monthly rent (<1/3) that when you quarter it in real terms, you end up with such a small amount, 30 years out, that it's not a big deal.
It'll be a nice bonus when it comes, I'm sure, but it doesn't materially change your calculations today.
Obviously if you do a 10- or 15-year mortgage or something, you'll look at it differently, but for a standard 30-year, it's not a huge impact, mainly due to inflation versus the fixed loan payment.
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Arebelspy - I don't know if you answered the OP's question, but you certainly answered one of mine. So thanks!
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Arebelspy - I don't know if you answered the OP's question, but you certainly answered one of mine. So thanks!
My pleasure. Glad to (inadvertently?) help. :)
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Are you setting aside 10% of rents for maintenance? Allowing for at least 5% for vacancy? Managing it for free?
You can count the principle paid off as 'income', but it is not cash flow.
I only count money in my pocket after those expenses. I cash flow a lot more than that, but I know there are capital improvements that always need to be made.
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Are you setting aside 10% of rents for maintenance? Allowing for at least 5% for vacancy? Managing it for free?
You can count the principle paid off as 'income', but it is not cash flow.
I only count money in my pocket after those expenses. I cash flow a lot more than that, but I know there are capital improvements that always need to be made.
Good point. I was assuming the OP was (since they said 12% gross, 6% net, e.g. right in line with the 50% rule), but but it never hurts to say it explicitly. :)