According to the Bible, the reign of King Solomon was marked by prosperity and wisdom. Throughout the books of Proverbs and Ecclesiastes, the monarch’s beliefs are expressed again and again: use good judgment, use money wisely and deal honorably with others. One aspect of using money wisely is allowing it to work for you. In the world of rental income property investing, one strategy for managing money prudently paradoxically involves remaining in debt.
Why is debt, so long considered the enemy of sound financial planning, an advantage in the world of rental real estate? In the aftermath of the housing meltdown of 2008 and beyond, many distressed and foreclosed properties were available for near-record low costs, enabling new investors to make quick purchases with cash. Yet these new property owners found themselves locked out of many of the tax advantages of property ownership, forced to use their own money for maintenance, and ineligible for any mortgage-related bailouts.
Jason Hartman’s basic formula for reaping returns on income property ownership involves purchasing as many properties as possible on a fixed rate mortgage. This locks in the repayment rate for about 30 years – payments which can be covered from rents paid by tenants. The larger the loan, the more support is provided by lenders. And with interest rates remaining low, it’s possible to secure financing for a large amount, which can be used to purchase either single family homes or multiplexes up to four units.
Another way that debt can work for the investor has to do with inflation. While inflation raises the price of consumer goods, so that the dollar you earn doesn’t go as far, it also reduces the value of debt. In periods of inflation, there’s a difference between the nominal value of a mortgage and its actual value – which is generally lower because the dollar’s value is being constantly devalued. So a mortgage has a real value that, depending on the rate of inflation, may be substantially lower than its nominal, or face value. With tenant rents paying down the mortgage on a regular basis, the investor can save a substantial amount on the debt owed.
Debt, in the form of mortgages that can be periodically refinanced, also offers tax benefits. Mortgage interest is tax-deductible, as is mortgage insurance. Real estate taxes are also deductible, and so are numerous other expenditures associated with owning and maintaining rental property. And a mortgage can be protected in the event of a natural disaster or other event that destroys the property. For example, after the disaster of Hurricane Katrina in New Orleans, mortgage companies put a moratorium on payments, freeing homeowners of their monthly obligations for up to six months.
To earlier Americans, debt was a dirty word. But as Jason Hartman’s investing strategies demonstrate, in the world of income property investing, the debt associated with mortgages can be music to an investor’s ears. As King Solomon knew thousands of years ago, not simply having wealth, but managing it wisely, is the key to prosperity.
The Solomon Success Team