Rental Income Part 2: In Its Defense

To the last post I thought I would add the criticism that the Rental Income course I took did not cover how best to make money in it.  Admittedly the course was focused on legal aspects rather than financial.  But I thought it was telling that the teacher stopped at one point and just said “Discouraged?  Rental income is still the best ROI out there…”

I happen to agree with her.  And it is because of equity.  The wisdom about home ownership is that you pay yourself via equity.  Well rental income is someone else paying you with equity!

I read a Warren Buffett book over the summer that said something like an investment is worth it if it can produce better returns than whatever else you could do with your money.  Well I use Vanguard index funds as a baseline, since they seem relatively easy to invest in, and produce reasonably reliable results given their index nature.  According to Mr. Money Mustache, who has been around investing and writing about it for much longer than I have, Vanguard index funds have a conservative but reliable 7% year after year ROI after adjustment for inflation.  I doubt I could do that well buying individual stocks, or even in my 401K after fees.  7% seems pretty great to me, but I still look to improve on it.

That’s how I got onto rental income.  If you buy cheap but in a good area, get quality tenants, and price your rent right, I think you could manage the risks enough to achieve > 7% ROI.  Very roughly: say you buy a 2 bed/1bath condo for $100K with a $20K down payment.   The monthly mortgage payment might be $600, the condo fee $400, and insurance and other costs $200/month.  Say you can get $1400/month rent for this unit.  You make $200/month, or $2400/year.  So each year you make say 12% return on your investment.  Add the $7200/year equity that your tenants are creating for you, and the annual ROI jumps to 48% (assuming stable property value).  And don’t forget the tax deduction on interest “paid”!

I realize the $200/month of liquid income is not really yours to enjoy.  It should be preserved in a liquid account earmarked for the inevitable renovation or repair cost.  But I’m ok with that!  If you bought in a nice neighborhood, I feel even the equity is money in the bank.  Inflation-protected money.

And even after the course, I feel pretty confident about being able to manage the risks.  If you have a bad tenant, you can get rid of the person within the year.  If things really go sour, you can lean on your insurance program.  And if crap really hits the fan, your property can be protected by a Limited Liability Corporation.  These things would not be good, but they would be downright intolerable if not for the high ROI.

A friend asked me today if I am “considering becoming a landlord.”  It sounded like a weighty and defining proposition when he put it that way.  But I think I would be willing to take a plunge of that nature in order to have others fund my investment vehicle.

3 thoughts on “Rental Income Part 2: In Its Defense

  1. I would love to eventually become a landlord. I think it’s a great return and could be kind of fun- especially if you were buying houses specifically to rent and got to fix them up first! These two posts are a little eye opening, though- I had no idea all of the legal issues involved!

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