Over the passed couple of weeks, we have shared a bit on rental investments and the current market; however, we’ve only begun to scratch the surface on this. We want to continue to dive in a bit more, in order to share just how an investment property (ie. house hacking, vacation, STR, LTR) might be good for you and your family. One of the huge reasons that families, and individuals, choose to invest in a rental is to pay for their monthly mortgage. Meanwhile they are also gaining equity and some extra income! 

There are quite a few ways to break down the investment property market but the following are amongst the most popular approaches. For reference, “house hacking” is when someone purchases a property, and lives in it themselves, while renting out a portion of the property for income. This could be a detached mother in law suite, or, maybe it is a multi-family property with several units. This is a great way to jump into the world of real estate investing. “Vacation” rentals are just as they sound- an investment property in a highly desirable location. The investor spends most of their time renting out the property but may enjoy the location for themselves and their family when available. It is a purchase where one can find enjoyment and extra income.

Then there is STR and LTR – Short Term and Long Term rentals. Short term is going to be AirBnb, VRBO, etc., with rental terms of one month or less. Long Term refers to a 6 month, or ideally, year or longer, lease. Long and Short term are both great options and can vary on success, depending on the city and the restrictions, etc. This involves specific research to decide which area would better suit STR or LTR (or both!)

So, in this market, what makes rental properties a strong investment?

“One of the most valuable tools rental property investors have in the U.S. is the 30-year fixed-rate mortgage. Surprisingly, this style of mortgage is very much an outlier compared to what’s typically offered in other countries. Most countries tend to offer adjustable, variable, flexible, or renegotiable rate mortgages, all of which pose an inherent risk with the potential of an unexpected interest rate hike during ownership of the property.

Not only are fixed-rate mortgages excellent for letting investors skip those unexpected rate hikes down the road, but there have been notable periods where the interest rates on these mortgages have been remarkably low, making the cost of borrowing money almost trivial. 

But what happens when those interest rates increase, potentially to levels we aren’t used to seeing? Suddenly monthly mortgage payments are noticeably higher, which hits our cash flow returns. Does it mean it’s time to slow down or stop investing in rental properties? How do you counter higher interest rates on your mortgage to stay profitable with your rental property?

The best way to decide this is by understanding how rental properties make money, the factors you can control in a rental property and its profits, and knowing what to look for in a prospective rental property to help set you up for the greatest chance of successful returns, despite a higher mortgage payment.

Rental Properties are Long-Term Investments?

One of the biggest things you should remember with rental properties is that they are, in fact, long-term investments. Sure, some people may see a quick equity profit through improvements or value-adds, and some may land deals with significant cash flow from the start. Still, as a general rule, you must remember that rental properties see the most profit over the long haul.

Often when we analyze a rental property’s finances, we only see the cash flow number that’s right in front of us. It’s easy to forget that the projected cash flow is simply what’s projected today. That number doesn’t account for rent increases over time (while keeping a fixed mortgage payment), appreciation, demand, and inflation. All of those factors will continuously change, hopefully for the better. 

How a Rental Property Makes Money

Before learning about real estate investing, you may have known that rental properties can be very profitable but not necessarily understand exactly how they can be so profitable.

The five ways that rental properties can make money are:

1. – Cash flow
2. – Appreciation
3. – Tax benefits
4. – Equity built via mortgage pay down
5. – Hedging against inflation

When you understand the details of each of these profit centers, you will not only become savvier about the power of holding a rental property for the long-term instead of the short-term, but you’ll also begin to realize that the expense of an interest rate that’s a couple of points higher than what you’re used to likely doesn’t hold a candle to the profit potential over the lifetime of the rental property.

You may already be saying, “But those other profit centers are speculative, and cash flow is still important, and the higher mortgage expense increases my risk by lowering my cash flow.” Yes, and that can very well be true. But what you want to do in this situation is two things:

Learn to balance the profit centers. If cash flow is down, which happens with a higher interest rate, look for other profit centers with potential. Maybe you’re buying in a gentrifying high-demand area, so you could speculate that appreciation potential is very high. Or perhaps you’re investing during a time of extremely high inflation. What could you do in that situation? Think of it like a bar graph with a bar for each profit center. If one is down, are any of the others up? If they’re all down, that’s a problem. If some are higher than usual, do those balance them? All of it depends on your unique situation.

Put a big focus on location and demand. Just as with that example, one of the keys is investing in properties that will lend their hand to the appreciation bar especially, as well as inflation and rent demand. As long as people desire the property they own, the greater the profit potential from the profit centers will be, and the more they will continue to increase over time.

When you understand how rental properties make money, you can begin to wear the investor hat rather than the consumer hat. It’s the consumer hat that causes people to think that increased interest rates are deal-breakers, whereas people who truly understand how rental properties profit will not only learn to see how to look past the interest rates but also give them perspectives on how to compensate for it.”