Let's assume you've selected the right house in the right location that can be rented at fair market rents; financed with loan payments less than net market rents. The next task is to clamp down on expenses. The key to controlling expenses in rental property is to rent to long-term residents who will be responsible for taking care of their homes. That means that they'll willingly perform minor maintenance and pay rent on a timely basis in exchange for the right to live in a decent house for as many years as they choose to. Tenants dislike moving as much as you do. If treated fairly, they'll continue to pay rent to you for many years.
By giving tenants an incentive to stay put, landlords are able to avoid the expenses of vacancy, refurbishing living quarters between tenants, and costs of rent-up including marketing and tenant selection. Stated another way, a long-term stable tenant will provide continuing cash flow with low operating expenses for many years, perhaps decades. I've had many such tenants.
Way back in 1979, I bought a house from a burned out landlord. I paid a $1000 down payment and took title to an existing supposedly “non-assumable” loan on which there was a $21,900 balance. I sold the house 21 years later for $76,000. One tenant lived in that house for 16 years. Over that period of time I averaged about $4000 per year in net operating cash flow after all expenses; using it first to pay off the debt. Let's look at the total investment yield that this produced:
In the first 5 years of ownership, almost all net cash flow was used to pay for repairs to bring the house up to neighborhood standards. By the time my 16-year tenant moved in, very little remained to be done. Depreciation just about covered the costs of repairs over the holding period. If you add $64,000 in net rents to $53,100 in gain due to price appreciation over the initial $22,900 price, you get a cash flow profit of $116,100 which was produced entirely by one tenant. I can't think of any other investment I could have made over the same period that would have produced this much profit with such a small investment.
A lot of people who don't like management, or who are impatient to start generating current cash flow at the expense of long term tax-sheltered profit, are dealers who buy low and sell high. Profit can take the form of a spread between the price paid and price received, interest paid and interest received, or a combination of both. Let's look at the differences in yield between renting the above house and selling it for about $37,000 after the initial 5 year period during which all cash flows were being recycled into improvements. This would be a little more than 10% annual increase in value compounded over 5 years, due in part to price inflation and in part to the improvements paid for by tenants. Based solely upon the $1000 invested, and without regard to any mortgage amortization, a $14,100 cash gain in 5 years would have amounted to almost 70% annual compound pre-tax return.
Suppose I elected to sell the house on a “wrap-around” loan. If I received a $3000 down payment, I'd have realized a 24.57% compound annual return over my $1000 purchase price after the initial 5 years. With payments each month equal to $100 over the payments required on the existing underlying loan, that would represent 120% per year return on my initial $1000 investment until the underlying loan was paid off, after which my yield would have more than doubled until I was paid off completely. Regardless of the high yield, the cash flow on my installment contract would have been fairly meager because of my high leverage. If I needed cash flow, I'd do much better selling for cash rather than on terms.
All of this is merely arithmetic unless you decide to take action to improve your financial position; particularly with regard to cash flow that might be needed for future investment, or to replace a job that you might want to leave. Without cash flow, there are few choices. With cash flow, there are many choices. It's up to you.
