How Small Rent Increases Build Net Worth
Posted on March 4, 2007
One of the big advantages to owning income-producing real estate is the effect that small rent increases have on your net worth. Net worth is simply the difference between the value of what you own and the amount of money you owe on it. Since the value of investment real estate is directly related to the income it produces, it makes sense that the value added each time a small rent increase is implemented will cause your equity to grow and increase your net worth. What may not be so obvious is the impact small rent increases can have over a period of years.
A good example of this is a basic starter home I purchased in a local subdivision back in 1980. I gave the sellers $620 and assumed their Veterans Administration (VA) guaranteed loan. (By the way, these loans are still assumable today.) The payment on the loan was $225 per month, which included the property taxes and insurance. The house rented for $250 per month. After making the payment, I gave the additional $25 per month to a property manager to handle it for me because I wanted to be an investor, not take on a second job.
That’s an important philosophy because most people would say, “Why pay someone else 10 percent of the gross income when you could easily manage the property yourself?” They think all there is to managing property is collecting the rent and depositing the check, but believe me there’s a lot more to it than that and I didn’t want to do it. Why would I want to spend my time unclogging toilets when I could be out locating and buying more properties? That’s enough on that topic; property management can be the subject for another column.
In this example, I only broke even that first year, or did I? Although I had no extra cash from the investment, each time I used the rent to make a payment; it reduced the amount I owed on the property. I ordered a loan amortization schedule and kept track of the amount of each payment that went to interest and the amount that reduced the loan balance. Although I had no excess cash, by the end of that first year I owed $300 less, so my equity had increased by that amount plus whatever amount appreciation might have increased the value of the property. That $300 may not seem like much, but considering that I only put $620 cash into the deal, it amounted to almost a 50 percent return on my investment. I would have had to deposit $5,000 in an account earning 6 percent interest to have earned that much in a year.
The second year, my property manager increased the rent to $275 per month, but the loan payment remained at $225. Now I began to see a trickle of extra cash and the loan continued to pay down each month. The year after that the rent was increased to $300 per month and by the time the next tax revaluation was done, rent had increased to $395 per month. That’s when I learned how small rent increases could snowball net worth.
During this period, my loan had paid down over $2,300, but the property had increased in value by more than $22,000. My equity had grown nearly 10 times as fast from the small rent increases as it had from paying down the debt. Today I still own the property, which rents for $950 per month. The tax assessor now values it at more than $121,000, which is all net worth because the mortgage has long been paid off.
Granted, more than 25 years have lapsed since I purchased this property, but let’s compare my return on investment with what I could have gotten from any other type investment. When I first bought the property, I put down $620 and other than normal maintenance, which was paid from the rental income, I have not made any additional investment. If I had been able to invest the $620 at an annual return of 20 percent compounded for 25 years, I would have less than $60,000 today instead of a property valued at more than double that amount. This doesn’t count the spendable cash flow the property has generated, which this year alone will top $8,000 after expenses.
In all our books, audio and computer programs, we advocate building wealth slowly over time. This is an example of what just one property, purchased the Weekend Millionaire way, can do over a period of years. Can you imagine what could happen if you owned 10, 20, 30 or more properties like this? You could possible retire earlier and have a better standard of living than you could with virtually any other type investment.
Here’s a tip! Be patient! Monthly cash flow builds slowly with real estate investments and most would be investors become impatient and sell without giving their investments time to mature. When you sell, it caps your profit at the time of sale. Once sold, whatever profit you make, that’s it; there is no more unless you buy another property and start over again. I’ve been buying income-producing properties for more than 35 years and have never sold one. It goes without saying that properties have to be maintained and I do that, but no one has ever given me a good reason to dispose of one when it’s producing income month after month.
There are lots of speculative ways to make money with real estate. Rehabbing, flipping, and wholesaling are just a few, but those are jobs and they come with high risks and should be approached with caution.
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