Much ink has been spilled over whether it is best to rent or buy. There are reasons to advocate for both sides; however, this is not an article about the advantages of one over the other. Instead, our underlying assertion is that all Millennials should own real estate, and in most cases, the sooner the better.
While renting out your home to people who have year-long leases is certainly a tried and true way to create income, it is by no means the only way. Gone are the days that you need to live in one half of a duplex and rent out the other side to have your property make you money. Chances are you have heard of short-term rentals (think Airbnb, VRBO, etc.) and probably stayed at one in the past. This can be a great option for people who are willing to share their space a few nights a month, rent it out while they are away, or build out a private unit that functions strictly to make the owner money. The real trick here is to buy a property that allows you to make more than your monthly expenses.
Leverage and Mortgage Paydown
Most people understand that rentals are a way to make money, but they usually underestimate the power of leverage. Where else can you pay 3.5% (sometimes less) for something up front, but get access to use 100%? This is what happens when you buy real estate. As a real estate investor, you can pay 3.5% as a down payment for a property, but if you rent it out, you aren’t limited to charging 3.5% of the rent for that property, you get to charge the full 100%. This is amazing! I could write for days about how ridiculously great this is for the real estate investor! It gets better though.
For all but the most advanced investors, properties will be on a 30 year fixed loan. This means that every payment from month one to month 360 will be the same. Yet because of inflation, we know that property value and rental income will likely increase over that same 30 year period, making a more valuable endeavor each passing year*!
Finally, if we assume that the rent income of a property only covers the expenses of that property, and therefore makes the owner no cash return, that owner still is making money! This is because mortgage payments are made up of interest and principal and if your tenant is paying at least enough to cover the mortgage payment, they are, in essence, paying the bank for you to own the property. The longer you do this, the more the tenant pays off your mortgage for you.
Now let’s say the time has come to retire. Put yourself in those shoes. What is your biggest fear? Well, if you said outliving your savings you would not be alone. A study done by the American Institute of CPAs found that 57% of financial planners said outliving your savings was the top retirement concern for their clients.
If we think about savings as a big bucket of money that we slowly draw on during retirement, wouldn’t it be really great if there was a way to consistently refill that without trading time for money, i.e. working? Lucky for real estate investors, that exists!
Continuing with our example, let’s say 30 years ago our investor retiree bought a property on a 30-year loan to live in for a season of life. After it made sense for our investor to move to a different living situation, they held onto the house and rented it out. Right at the time our investor wanted to retire, that property would be paid off, meaning they no longer had a payment to make and therefore the amount of money that hits their bottom line goes up dramatically. What great timing! Just as their W2 income from their former job decreases, they get an increase in cash flow from the rental property allowing them to be supplementing their retirement savings every month, while still being retired.
While there are plenty of things this article doesn’t address about owning real estate (tax benefits, being a landlord vs having a property manager, types of property to invest in, etc.), hopefully it can help open up new ways of thinking about your retirement portfolio and generating long-term wealth in a sustainable manner.
*Real Estate values and rental income do not go up exclusively every year. There are fluctuations within the year, as well as in the market over time. On average though, these metrics trend upwards.