In the last post, we learned how to “do the math” on a rental property. If you haven’t read that one, go back and check it out.
OK… so having read that, you’ve got the basics on what it costs to own a rental property, and what it costs to operate it.
With those figures determined, you know if you have positive, negative, or neutral cash flow. Cash flow can be important, but it is far from being the only way to make money with a rental.
In this post, let’s talk about the first of the other ways rental properties can make you money.
Historically, property values go up over time, a phenomenon known as appreciation. Some years are better than others. In 2018, Bellingham’s average appreciation was north of 12%.
Some years see values go down, like 2009 through 2012 in the Bellingham market, following the Great Recession. (To be clear, as I write this in the midst of the Covid-19 pandemic, we are likely to see values go down somewhat in the short term future ahead. More on that later.)
But on average, even through market downturns, the average value of Bellingham real estate goes up. Going back to 2003, the average annual appreciation has been 5.15%. That is including the years through the Recession.
And that appreciation is happening whether or not you’re seeing positive cash flow. The key is to give the property time to appreciate. How much time? Let’s use 10 years as a nice, safe time period. As we tell our clients, the longer you hold a property, the more you mitigate the risk of over-paying on the front end, or being caught in a down-market when you sell.
In our example property in the first post in this series, we paid $500,000 for the house. We rent it out, take good care of it, and let the market do its average 5.15% thing for a decade.
After year 1, that $500,000 value has gone up to $525,750. A cool twenty-five grand in extra equity.
After year two, that value is now $552,826. We’re starting to really get somewhere.
After year FIVE, our rental house has a market value — on average — of $642,712. Remember, this is unrelated to the cash flow.
After year TEN… our $500,000 three bedroom, two bathroom rental house in the heart of Bellingham, has a market value of $826,157.
So while you were only pulling $1600/year in cash flow on year 1 — which is (let’s be honest), basically “breaking even”, you’ve been making some serious money through the magical effects of appreciation.
(Imagine having 10 of these rentals… ALL doing that nice 5.15% year over year in appreciation! It’s no wonder why Real Estate is the single biggest asset class (holder of wealth) in the world).
In the next post, we’ll look at the second of 4 additional ways your rental property makes you money BEYOND cash flow: Principal Paydown!