Rent-yielding Real Estate - a Smart Investor’s Choice

By
Telukunta Sai Kinnera,
Rent-yielding Real Estate - a Smart Investor’s Choice

Perhaps you've thought and considered venturing into the realm of real estate investment yourself, and are attracted to the idea of becoming a rental property owner and earning good revenue from it. With real estate property ownership rates at their weakest levels in 50 years, now might be a great time to explore the opportunity.

Know the Basics

While most of you think that the sphere of investable asset classes is vast and offers a variety of options to investors, it surprisingly boils to fewer choices in reality.

The asset classes thus include:

The Income-generating Real Estate Assets

An income-generating property is a property that is bought and developed with the motto of earning revenue from it.

Income-generating properties are several, and they include residential real estates such as single-family homes or multi-family homes, and commercial properties such as a retail mall/store, a warehouse, or a hotel. Owners generate money through holding and renting the property while it appreciates and then sells it for a profit.

Non-income Generating Real Estate Assets

Non-income generating assets are those which are bought for personal purpose and not intended to rent them out or generate money from them.

This class includes your home, your vacay home, your term insurance policy, etc.

Evaluation of Investment

Any smart investor evaluates an investment based on four factors:

Capital Preservation and Return Risks

A clean capital preservation approach would mean investing in securities issued by the government like a treasury bill or government security. But, even these are prone to interest rate risk.

Interest rate risk suggests the chance of the value of the security going uphills and downhills depending on the variation in interest rates. When interest rates decrease, securities with higher interest rates become more precious, and vice versa. The sensitivity of a security to its interest rate depends on duration. Less is the length of duration, and lesser will be the returns. So, investors must watch out and evaluate it properly.

Inflation

Inflation is the appreciation of prices of goods or property or any real thing as such, over a while. Any investment must, hence, be a quantum against a yardstick of inflation to see whether the returns at least cover the erosion in the value of dormant capital.

Since inflation is a gradual process and quite un-perceptible, investors most probably overlook its effects over the short to medium term, which is a mistake many seasoned investors make in portfolio allocation.

Liquidity

Liquidity is mostly an operation of the whole investable surplus. Every investor should keep a particular portion of their total holdings in assets, which can easily be liquidated to cater to the unusual and emergency needs.

A shrewd investor will be able to blend a strategy with debt, equity and hybrid securities managed actively to generate optimized returns on a portfolio having in mind these ideas of capital preservation, risk-adjusted returns, inflation, and liquidity.

Commercial Rent-yielding Real Estate Overview

Commercial real estate generates 8-9% annual returns through rental yield. It gives an opportunity to participate in the appreciation of the property value, providing it characteristics of both the debt and the equity. Because the property is a real asset, the principal amount can also be considered substantially safer. The real feather in your cap is the annual inflation-linked rent escalations. Most commercial leases increase by 5% every year or 15% every three years, giving a substantial cushion against inflation. The real rate of return is always. Therefore,  8-9% with the capital/value appreciation, presenting the additional equity kicker.

If investing in an institutional-grade property with a well-established tenant, the risk of rents not being paid or the tenant vacating can be tremendously decreased. A seasoned real estate investor will enhance stickiness by requiring the tenant to do the fit-outs or TIs and by signing a "lock-in" ( a term used to adhere tenants to a building for a longer-term).

As rents are paid regularly, i.e. monthly, the recurring monthly cash flow is an essential source of steady annual income that can be reinvested in other assets like a Systematic Investment Plan (SIP) or withdrawn to meet any immediate expenses. With a sufficiently large investment collection diversified across tenants, various geographies and asset classes, these monthly C-O-C returns can ultimately make the investors financially independent.

Perks of Investing in Rent-yielding Real Estate

Passive Income Source

Most probably the most significant benefit of owning a rental property is that it's a passive income source. This means that it is a recurring income that requires a comparatively less effort to maintain. It can be an alluring option for people looking to make some money on the side, or even for those who seek it for extra financial safety during retirement.

Greater Security

There are many reasons that people may have to leave the property empty (for a job or so). A vacant home most likely invites destruction and squatters, and maintenance issues also go unnoticed that can quickly intensify into more significant problems. It's hard to keep an eye on a home continually you aren't dwelling in. Renting the property out to occupants can give you a greater peace of mind that the house is being maintained and looked after.

Flexibility to Sell or Occupy

Say you're ready to relocate, but the market conditions aren't right. In such a case, rather than selling your property for a loss, you can simply rent out your property until market conditions improve. Thus, renting out your property comes as a rescue in such situations.

Also, if you need to make a temporary move for a job or so, it's nice to know you'll still have a place to stay in when you return. Anyways for that, you'll want to check your state and local housing laws and respect the terms of your lease/rent with any current tenants.

Value Appreciation of Property

Renting out your property allows you to secure your property and in case it appreciates, it provides you with the option to dispose of the property when the time is right. The amount of appreciation is going to differ by market. Analysis of the appreciation potential of various cities and neighbourhoods to see what you might be able to expect.

Investment Diversification

Owning a rental property is good for the health of your investment portfolio. It allows you to diversify your portfolio, which can serve as an extra layer of protection against risk. It also helps you take advantage of favourable market waves.

Provides You Leverage

Owning rental property provides you with higher leverage when applying for a loan. Real estate investment is relatively a safe bet, and even the banks have an idea of that. This enables you to buy a rental property without excavating your pockets for 100% of the purchase price. Borrowing money from the bank or some other financial institution causes an increase in the potential return.

Tax Benefits

Investing in real estate gives you an exceptional opportunity to access a collection of rental property tax deductions. Some of them include:

Interest

As a proprietor, you can deduct interest from pre-existing mortgage interest payments utilized in buying the property.

Repairs

You can avail the tax benefits in the cost of repairs in the year they are carried out. If you fix the door or repaint the building or carry out some repair works of lights, ceilings, etc., the costs can be deducted.

Depreciation

When the rental property is generating income, you can get a tax benefit for owning that rental property, which is achieved by way of depreciation. To this end, owners can deduct the cost of the property in years to come.

Insurance

Another benefit that comes handy is the deductions from insurance premiums regardless of the insurance policy that is associated with your rental property. This may consist of flood/fire/theft insurance or owner insurance.

Final Thoughts

The critical thing to keep in mind is that investing in rental properties is one of the many options on the table. You have to take into consideration your financial state, your strengths, and your interests and make up your mind about rental properties and then proceed with investing in them. All in all, it's one of the smartest investment options available in the real estate segment that can yield you a substantial amount in the long-term perspective.

FAQs:

There are two asset classes of real estate. They are:

  1. Income-yielding real estate - includes single-family, multi-family homes, commercial properties, etc.
  2. Non-income yielding real estate - includes your home, your vacay home, your term insurance policy, etc.

An investor must consider the following factors:

  1. Capital preservation,
  2. Return risks,
  3. Liquidity.

There are many benefits that the rent-generating property owner can enjoy. They are:

  1. Passive income,
  2. Tax benefits,
  3. Greater security,
  4. HIgher leverage,
  5. The flexibility of selling or occupying,
  6. Capital appreciation,
  7. Investment portfolio diversification.

The recurring monthly cash flow earned from commercial real estate properties is enormous, and it serves as an important source of steady annual income that can be reinvested in other assets like a Systematic Investment Plan (SIP) or withdrawn to meet any immediate expenses. With a sufficiently large investment collection diversified across various components, these monthly cash-on-cash returns can ultimately make the investors financially independent.