So, why isn't everyone becoming financially independent by investing in real estate? Thomas explains that most people don't understand the principle of compounding wealth. Because of this, people don't remain committed to real estate investing.
To make the point, Thomas asks us to consider taking a 35-day job where we can be paid either one of two ways. First, we can be paid $1,000 daily. The other option is being paid only a penny the first day. Then, for each of the next 34 days, our income will double. The temptation is to take the $1,000 per day for a total of $35,000. But, via compounding, the penny-a-day option grows into an amazing $343,597,363.21.
Similarly, Thomas observes that many people who get started in real estate investing abandon it after only two or three years because they feel they aren't generating any noticeable dollar return on their real estate investments. Thomas advises, "You should make at least a five year commitment to real estate if you want the chance to experience substantial financial rewards."
Most people abandon real estate investing when they only see the pennies in the first few days.
Thomas says that each rental property you acquire will probably take about two to three hours per month to administer and that real estate investing can be the ideal home business. She points out as few as five rental properties can provide a core, livable income in five to ten years.
The Chapter, "Rates of Return on Rental Real Estate," is especially valuable. Thomas shows new real estate rental investors how to calculate the rate of return they are achieving on their rental properties.
This rate of return, Thomas explains, is composed of three main parts. First, there is the potential property appreciation. Second is the rental cash flow from the properties. Third is the "principal paydown," i.e., as the years pass you acquire more equity in your rental real estate. Thomas also allows for the tax saving acquired because the IRS lets you depreciate rental real estate from a tax standpoint, even though your property is probably actually increasing in value.
The Chapter, "Rates of Return on Rental Real Estate," calculates the rate of return on one of Thomas's actual, Colorado rental properties showing how it achieved a 30% annual rate of return. Rental real estate returns tend to decrease slightly with time, Thomas explains, because as you own the property longer, more and more of the principal on the loan is paid down. Hence, you are using less and less financial leverage. So, while the return on a rental property just purchased might be 30%, the rate of return on a fully paid-for property might only be 12%.
Partially due to this factor, Thomas likes adjustable rate mortgages over fixed rate mortgages for her rental properties. While prepaying a fixed rate mortgage has the tendency to shorten the length of the mortgage, it does nothing to reduce your monthly mortgage payments, she explains. We want to keep our rental properties leveraged to increase returns, so shortening the length of the mortgage isn't fully beneficial. And, it costs money to extract cash by refinancing properties in which we already have much built-up equity, so that we can invest the money in different, and more highly-leveraged, rental real estate.
But, when we prepay on adjustable rate mortgages, Thomas explains, the effect isn't to reduce the length of the mortgage, but rather to reduce our monthly mortgage payments. This increases the investor's cash flow and allows the money to be reinvested in new real estate properties (or, as Thomas did, allows you to retire earlier).
Thomas also discusses the risks associated with choosing adjustable rate mortgages for real estate properties. She doesn't view adjustable rate mortgages as being as risky as many people think they are. Thomas says this is partially because, as interest rates rise, more people won't be able to afford home buying as an option, and there should be more renters. So, rents will probably increase with increasing interest rates.
Thomas recommends making extra payments toward principal on your rental properties' adjustable rate mortgages. This has the effect of reducing your monthly payments without shortening the length of the mortgage. Thomas shows that, by making extra payments toward principal, you can reduce your monthly payments so an increase in interest rates won't overwhelm your capacity to pay down your real estate mortgages. By reducing your monthly payments via prepayment, you will create a buffer to help shield you from increasing interest rates.
Thomas suggests that you can also diversify your real estate mortgages by having some fixed rate mortgages along with some adjustable rate mortgages.
"Rental Houses for the Successful Small Investor" also gives the real estate investor useful information about:
--Finding The Down Payments For Your Properties
--Selecting Rental Real Estate Properties
--Rental Real Estate Loans
--Qualifying Potential Tenants
--Day-to-Day Details Of Running Rental Properties
--The Lease And Important Clauses To Protect Yourself And Your Rental Properties
--1031 Tax Deferred Exchanges Of Real Estate
The chapter about reducing your taxes, via 1031 Tax Deferred Real Estate Exchanges, and the information throughout Rental Houses for the Successful Small Investor about reducing your taxes on real estate investments is especially valuable.
If you are contemplating investing in real estate and, in particular, investing in rental properties, I highly recommend buying a copy of "Rental Houses for the Successful Small Investor" by Suzanne P. Thomas. The book is highly readable and packed with useful information to help you get started in real estate investing.
Peter Hupalo, Author of "Thinking Like An Entrepreneur" and "Becoming An Investor"
Suzanne covers many of the pitfalls associated with Real Estate Investing as well and I like that. Too many others make it appear as though R.E. Investing is a slam dunk, invest, rent your property and wait for the checks to come rolling in. Not so.
Overall a good book by Suzanne. Great for novices and experienced alike.