GB #1: Playing the Long Game with Rental Properties

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Today we have a guest blog from Eric Hughes of Rental Income Advisors. Eric Hughes used cash-flowing rental properties to leave his corporate career at age 39. He started Rental Income Advisors in 2020 to help other people achieve their own goals through real estate investing. His blog focuses on learning & education for new investors, and he serves as a private coach to others starting their own journey with rental properties.

As a real estate investor and private coach, the lesson about rental properties that I’ve come to appreciate more than any other is this: rental properties work best as a long-term investment.

Like, REALLY long term.

This isn’t just because there are inevitable short-term ups and down with rental properties (though there certainly are.) It’s also because your ROI – both cash returns and equity growth –will naturally increase over time. 

Here’s the real truth: rental property investing isn’t a get rich quick scheme. It’s a get rich slow scheme, a long-term play. The biggest returns come in the later years, not right out of the gates. The engine starts slowly, but accelerates over time.

In this article I want to share SEVEN key ideas about rental properties, all of which are related to the long-term nature of the investment. Once we accept that we’re in this for the long haul, a lot of what you’ve probably heard about real estate (i.e. while watching HGTV shows, talking to your buddies, etc.) becomes much less important.

Here’s what IS important.

Key Idea #1: Returns Increase Over Time

Unless you plan to hold your properties for at LEAST five years (10+ years is much better), don’t bother. Buy index funds instead, and forget about real estate.

Why is this? Because the richest rewards come later in the process. There are a number of factors that drive this dynamic:

• Cash flow increases over time
• Rent increases over time, while your mortgage stays the same
• Mortgage paydown accelerates over time

When we “run the numbers” on rental properties to estimate what our returns will be, it’s pretty common to see 15-20% total returns when cash flow, mortgage paydown, and leveraged appreciation are added together. This is an outstanding rate of return, of course, and that’s why we love rental property investing!

But those numbers don’t tell the full story because the pro forma only shows you the “year one” numbers. A few decades out you’d be looking at 50-75% returns on your invested dollars (not inflation adjusted).

Sound too good to be true? Financial models should help convince you. Let’s take one of my actual properties as an example: I bought this house in 2022, in perfect turnkey condition. As you can read about in the linked article, I projected 4.8% cash-on-cash and 14% total returns in Year 1 (assuming 2% home price appreciation). From a cash standpoint, that means I’d be looking to make $1800 annually on my $36K invested.

Solid enough, but nothing spectacular.

But let’s project this into the future with an average annual inflation rate of 2.5%. Let’s also make the very reasonable assumption that rent, the value of the home, and all expenses (other than the mortgage) will increase at the rate of inflation. Here’s what the numbers look like in Year 10, Year 20, and Year 30, and it’s a dramatically different picture:

You can see that between Year 1 and Year 30:

• Annual cash flow grows from $1,700 to $11,000
• Annual total returns grow from $5,700 to $24,000
• The rate of total returns on invested cash grows from 15% to 65%.
• Over the course of those 30 years, my total returns are $399,000.

The point is this: Year 1 is just the beginning.

We’ve got to have a long-term time horizon to make this work. Personally, I plan to hold my properties forever. Now that’s playing the long game!

Key Idea #2: Short-term is hard to predict, long-term is easy to predict

This might seem counterintuitive, but it’s true. These days, investors generally accept this principle about the stock market – they know it’s volatile in the short-term, but tends to go up in the long-term. Therefore, it’s nearly impossible to predict what will happen next month, but relatively easy to predict what will happen in 20 years. (In fact, no 20-year period in the 100+ year history of the stock market has ever produced negative returns.)

These exact same concepts apply to rental properties. We don’t know what will happen to home prices in the next year, but it’s quite easy to predict what they’ll do in the next 20 years – they’ll go at about the rate of inflation, as they always have. This, combined with a 30-year fixed rate mortgage, is almost certain to make you lots of money.

Home prices aren’t the only source of volatility with rental properties, though. You’ll also have cash flow volatility thanks to maintenance & repairs, unexpected capital expenditures, and tenant issues such as evictions and vacancies. In any given year, a single property might do great, or it might lose a bunch money. In the long run, though, it all averages out to a big win.

Key Idea #3: Time in market beats timing the market

This follows directly from key idea #2. Once we accept that we can’t predict the short-term, but CAN have reasonable long-term expectations, a clear conclusion follows: get in NOW.

Don’t wait. Don’t over-analyze. Don’t try to time the market. Deploy your money now so you can get to those “out years” faster.

Don’t underestimate the power of time in market. Here’s a shocking fact: even if you knew home prices would drop by 10% by this time next year, it would STILL be better to buy your rental property now at the higher price than wait a year to get the lower price. 

Key Idea #4: Keep it simple

At this point you might be wondering, is it really that simple? Just buy a house and hold it a long time? Don’t I need to find motivated sellers so I can get a great deal? Don’t I need to find the ugliest house on the best block? Don’t I need to find a fixer-upper so I can force appreciation and achieve “instant equity”? Don’t I need to buy in the path of gentrification? Don’t I need to…

The short answer is NO. You don’t need to do any of that. And it’s all because of the long-term investing horizon we have. When you look at your total returns over decades, getting a slightly better initial deal on a house means almost nothing. Ditto for value-add rehabs. Again, the math of rental properties prove that these are facts, not opinions.

Alternative buying strategies aren’t needed. Making money “at the closing table” isn’t the goal. Keep it simple, and don’t let perfect be the enemy of good.

Key Idea #5: Be ready to ride out the storms

Rentals are pretty stable. Most months, nothing at all happens. Some months, you might have a small repair cost. But every now and then, things will go wrong — VERY wrong.

Your tenant will stop paying, and have to be evicted. You’ll have to replace the roof unexpectedly, costing you thousands. The HVAC goes out; a storm blows down a few trees; the sewer backs up and needs to be replaced; and so on.

All these things have already happened to me many times, and they WILL happen to you if you’re in the business long enough. You have to be mentally ready for this. These things are budgeted for in your numbers, but they’re extremely “spiky”, and only average out in the long run.

Key Idea #6: For a smoother ride, scale up

Want a reprieve from the inevitable short-term ups and downs of rental properties? The best solution is counterintuitive: buy more of them! Scale up. The more properties you have, the easier it is for your portfolio to absorb the occasional downswings at any one property and produce cash flow you can count on.

Case in point: I have 25+ properties, and while my cash flow is still somewhat swingy from month to month, I’m nearly always positive. Over a year’s time, it’s VERY stable: I can confidently predict my annual cash flow within a very narrow range, ~$90K-$110K at the moment. It’s like clockwork.

Key Idea #7: It’s a marathon, not a sprint

To achieve the long-term rewards, you have to hold on. And hold on. And hold on. (And hold on.)

If you jump ship at the first sign of trouble (or the second sign, or the third sign) you will miss out. Sounds easy enough, but you’d be amazed how many investors make this mistake.

Summary

1. Returns increase over time
2. Short-term is hard to predict, long-term is easy to predict
3. Time in market beats timing the market
4. Keep it simple
5. Be ready to ride out the storms
6. For a smoother ride, scale up
7. It’s a marathon, not a sprint