First, you make money through net cash flow, principal or equity, appreciation, and tax advantages. If you choose to be a landlord, your net cash flow is the difference between what you charge for rent and the monthly mortgage payment, including principal, interest, taxes and insurance. Unless you get the property at well below market value, it is a good rule of thumb to make at least $100 per month to offset the occasional repairs, fix-up costs, and move-in/move-out costs.

Equity is the amount of the original purchase price that you are actually paying off each month. The shorter the mortgage term and the lower the interest rate, the more equity you will accumulate.

Appreciation is by far the best part of real estate investing. Time is your friend. By investing in “bread and butter” houses (a term I picked up from Robert Allen [1990]) in good locations, the value of your house will rise each year. The better the location is, given a good economy, the higher the appreciation. In my area of Johnson County, Kansas (a suburb of Kansas City, Missouri), houses have appreciated over 7 percent per year for several years.

Finally, tax advantages include the following deductible items: depreciation of the property and other equipment, taxes and insurance, repairs and supplies, mileage, and office supplies used for the property.

That sounds pretty good so far. Are there any disadvantages?

You bet! First, if you buy a house using creative financing or if you buy a repossessed home, you are in for some fun times. Get ready for cleaning, painting, replacing carpeting, removing trash, mowing, raking, repairing plumbing, installing fixtures, replacing furnaces or air conditioners, and whatever else is needed to get the property sold or rented.

I recall a Veteran’s Administration (VA) repossessed home that my wife and I bought in January 1996. While fixing it up, we heard several loud creaking sounds that eventually were followed by water spewing from broken copper pipes. Had we not been working when the water pipes thawed, the house would have been flooded. Luckily, the VA paid the plumbing bill because the pipes were apparently frozen when we bought the house.

Next, advertising for and securing a decent renter can be expensive and time consuming. The screening process for renters is often an arduous process of phone calls, screening, and crossing your fingers. If you are not nervous about renting your property, I suggest watching the movie Pacific Heights. Regardless of what your lease says, renters have inherent rights and, in the unfortunate event of eviction, you often lose.

Repairs are the Achilles heel of the rental game. After purchasing my first rental property, a continuously clogged sewer line led to installing a new line. Thank you very much – there went all of my annual net cash flow (approximately $1,200) in one fell swoop.

Finally, if you think that selling a property is as easy as a classified advertisement and a sign in the yard, you are wrong. Once a property has been labeled a rental house, its inherent value is slightly lower than owner-occupied houses. Even in a good market most buyers use a real estate agent. Why not? It’s free after all. The seller has to pay the realtor fees, right? In actuality, the fees come from the real estate transaction and it may appear to be free, but really both the buyer and seller are paying the fees. 

If I haven’t scared you away, then get started in your own real estate investing career now.