You might remember that monthly income projection is based on RV Ratio™, which is (in a perfect world) .7 percent. .5 percent is the least acceptable ration, and .6 will do. Assume a property is only rented 11 months out of the year. If you buy a house for $18,000, you’ll rent it for $110 per month. If the house is $31,000, you’ll rent it for $189. Annually, you’ll make $1206 is the first month.
If the RV Ratio™ in 1972 is .6, $1206 with a one month vacancy, the payments are $1,211 per year, which is $5.00 per year negative cash flow—not too bad. But what does inflation do to rental income?
Simply put, it attacks it. So you might raise your rent—but inflation chips away at the value of that money as you receive it, meaning that your rental income only keeps up with inflation. If we jump forward to 1984, when Jason Hartman was graduating, inflation has made a dollar worth only 40 cents. While the number on your checkbook is $1,211 per year, the real value is only $487. Your rental check is $101, but in real value—only $41.
After tax benefits, that’s $371 annually (which doesn’t include depreciation). In 1984, the house is worth $33,182 and rental income (with a .6 RV Ratio™) is $199 per month. Annually, that is $2,200. Real rental income has been attacked by inflation and is $880. Your net real cash flow is $220 every month.
It’s easy to look at a loan document and note that you’ll be paying much more if you spread your payments out over a number of years. It’s easy to want to pay loans off because these numbers look big and scary. Resist that urge—the only reason to pay off a loan is in the case of consumer debt with interest rates higher than the coming inflation.
If you had to pay back $36,000 on a loan amount of $14,000 it would appear that you are paying three times the amount. The loan amount (7.37 percent) combines with inflation so that we are effectively paying only 1.06 percent to borrow this money. After taxes, we pay only $12,655 and our effective rate is negative 1.16 percent. You’re getting paid to borrow money. Assume these numbers are for a personal home—rental properties get a bit more complicated.
If rental income was $81,000 over 30 years, our return on investment is 10.74 percent. The real value of the rents was only $30,000. They rise a little faster than inflation.
Things are getting more expensive, which means that investors are getting paid to borrow money. You get paid if you lived in the house, rented out the house, simply left the house vacant. So borrow money—it pays off.
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The Jason Hartman Team