The rental property real estate investor strives to profit from their investment in two ways:
1. Monthly positive cash flow over all expenses including the debt service.
2. Equity appreciation to sell at a profit over the purchase price in the future.
Even though they’re making a long term investment, rental property investors also realize that they should have an exit strategy in their plan before they even make the property purchase. They should have a plan for how long they expect to hold the property, the hoped-for appreciation in value based on current estimates of market growth, and a pretty firm grip on expenses and debt service to guarantee great cash flow.
Let’s say that you’re a rental home investor and you can purchase a home for around $209,000. After you’ve covered closing costs and the down payment, you’re borrowing $165,000. You can get this mortgage for $911/month at 5.25% interest over 30 years, or you can take out a 7 year ARM at 4.875% and a payment of $873/month. This is a $63/month difference.
An analysis of your rental market indicates that you can rent this home out for $1,500/month. You’ve already calculated expenses and determined that costs and debt service are $1200/month with the 30-year 5.25% mortgage. The $300/month cash flow is acceptable, but $363/month represents an additional 21% in monthly cash flow. If your exit strategy includes selling in 7 years or less, this could be a good approach.
In considering whether this would be the right decision for your investment, here are some other points:
• If selling 7 years later, the payoff at 5.25% would be approximately $145,837.
• If selling 7 years later, the payoff at 4.875% would be approximately $144,737, a difference in profit on the sale of $1,100.
• At $63/month extra income, you would have taken in approximately $5292 more in income over that 84 months assuming full occupancy.
Every investment is unique and only running all of the numbers and matching them to your goals will determine what you should do.
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