Many people worry about real estate values decreasing when purchasing a rental property. I consider real estate values and appreciation when buying property, but it is not my primary concern. If real estate values decline I will be just fine, because I buy properties below market value with plenty of cash flow. My main concern is how much cash flow I make compared to how much cash I have in a property, not how much values will increase.
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I am making at least 20 percent cash on cash return on all of my rental properties. With this kind of return I don’t need my properties to appreciate to come out way ahead. However, my properties have appreciated in the last two years and I consider that a bonus. Check out my complete guide to investing in long term rental properties to see detailed numbers, how I find properties and how I finance properties.
Cash flow is more important than declining real estate values with rental properties
On my rental properties I try to cash flow at least $500 a month. That leaves me plenty of room for rents to decrease or for unforeseen repairs. I plan to hold these investment properties long-term so the only reason to worry about appreciation is if I need to refinance them. Even then, I think of refinancing my rentals and taking out cash as a bonus, not a critical part of my business model. Because I am investing for cash flow I do not need to sell my houses if the market decreases. Investors get in trouble with real estate when they are forced to sell in a down market. If you can avoid the need to sell your investment properties when values are down, you can avoid losing money or possibly losing much more.
What can you do to avoid selling rental properties in a decreasing market?
1. I buy properties with a 20 percent down payment because it increases my returns. The down payment builds in equity as soon as I sign the paperwork and should allow me to sell the home even if prices go down. Yes I will lose money if I have to sell right away, especially after factoring commissions for agents, title insurance, recording fees and the decreased price, but I can still sell if needed.
2. I buy properties that are below market value and add value through repairs or improvements. I only purchase properties that are at least 15 percent below market value. I also buy properties I can add value to by adding a bedroom or making repairs. When the property is ready to rent, my mortgage is usually 60 percent or less of the value of the home. This leaves me plenty of room to sell if needed.
3. I don’t plan to sell! I plan to collect rent every month, continue to build my wealth and pay down my mortgages. If the market goes down and I don’t want to sell it does not affect me at all. Even if rents go down, I have enough room in between my mortgage and rents to absorb a rent decrease and still cash flow. Historically values have always gone up over time. If I can wait out a drop in the market, eventually prices will go back up again.
As long as you buy below market value and invest for cash flow, a decrease in real estate values will not hurt you. Hold on to the property, continue to collect rent and wait for the market to bounce back. If you are buying your first property and cash is really tight, maybe you should save up a little more before you buy. If you really want to jump in the game as soon as you can, follow the rules above and if the market declines you will be okay. Here is an idea of how much you will need for a rental property, and how you can get into a rental property with less cash if you are just starting out.
For more information on how to buy the best rentals which will make the most money, check out my book: Build a Rental Property Empire: The no-nonsense book on finding deals, financing the right way, and managing wisely. The book is 374 pages long, comes in paperback or as an eBook and is an Amazon best seller.