Understanding the value of cash flow in rental home investments cannot only optimize your investment , but also secure financial growth over time . This article seeks to demystify the multifaceted nature of cash flow in rental properties , particularly with the use of a 30year fixed rate loan .
For starters , it ' s crucial to understand the basic premise of buying a rental home using a small down payment and a 30year fixedrate loan . This financing strategy entails constant principal and interest payments throughout the term of the loan . The total of principal and interest ( PI ) payment does not fluctuate regardless of inflation . That means inflation becomes a “ friend ” to the owner , as it constantly makes all prices rise EXCEPT the fixed mortgage PI payment , as well as the fixed mortgage ’ s balance . As a result , with the passage of time , and thanks to inflation , the REAL value of the fixed loan becomes eversmaller since the price of everything rises constantly with inflation , while the mortgage payment and balance never do .
Historical data shows that rental rates usually trend upward with inflation , on average . While inflation may seem daunting for many economic sectors , it is
a boon to the rental housing market . Property owners stand to gain increased revenue over time , as rents rise but the mortgage PI payment remains the same , which positively impacts their overall cash flow . As the home value also rises with inflation , the owner ’ s equity rises as well , building the owner ’ s net worth .
Often , investors and real estate novices interpret ' cash flow ' as the initial cash flow that occurs at the time of purchase . This perspective , however , is limited , and does not give a comprehensive picture of the lifetime behavior of the property . While the initial cash flow is undoubtedly an essential factor to consider , it should not be the sole determinant of a rental property ' s value .
The owner of the rental home enjoys constant cash flow improvement as rents escalate due to inflation . While rental income grows , the principal and interest ( PI ) mortgage payment remains static due to the fixedrate loan . This discrepancy creates a widening gap between income and expense over time , increasing the rental home ' s profitability . Hence , an investor ' s cash flow does not stagnate at the initial point of property purchase but continues to rise in a beneficial cascade over time .
Given this evolving nature of cash flow , it ' s more realistic to consider it over the years rather than focusing solely on the initial cash flow at the moment of purchase . Viewing cash flow as a longterm component can guide strategic decisionmaking , enhancing the likelihood of generating substantial financial gain over time .
At the risk of repeating myself ( and this is so important for our future I think it bears repeating ), the owner also benefits from an everdecreasing real dollar value of the loan balance due to inflation . The principal of a 30year fixedrate loan does not increase with inflation . Over time , the principal balance decreases in real dollar value , making the debt easier to handle as years go by . This phenomenon becomes even more pronounced when an investor owns several rental homes . Once the loan balances reach a low point , say 25 % of the home value , an investor can opt to sell several properties . After accounting for taxes ( even if no taxdeferred exchange is used ), the proceeds can be used to pay off the remaining loans . With the remaining properties free and clear , they can provide a significant boost to the owner ' s cash flow , creating a more secure financial footing . That is also an important facet of “ cash flow ”. Many people retire powerfully at that stage . Even though the loan is called “ 30 years fixed ”, we don ’ t have to wait for 30 years , a scenario like the one described above typically happen in 1214 years .
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