Is your rental property an asset or a liability?

By Joel Persinger

It seems that were ever I go someone says, “I understand you’re in real estate.” This last week a fellow said exactly that and began to quiz me regarding his rental properties. As it turned out, he had some rentals which were clearly assets and others which were liabilities and he could not figure out the difference.

In school we are taught that an asset is something that we own and a liability is something that we owe. But, this is not exactly correct from an investment point of view. Somebody once said, “When you’re not working an asset with feed you and a liability will eat you.” I don’t know who said it first. What I do know is that my grandfather must have said it to me a zillion times as I was growing up and I’ve read similar quotes in several books I could mention. The question is, “What does it mean when we apply it to real estate?”

Real estate investments come in all shapes and sizes, but for the purpose of this discussion we’ll break them into two categories: short term/speculation and long term/cash flow. Both of these investments can yield a positive result as long as you don’t get them confused.

Short term or speculative real estate investments are like stocks you buy and sell as a day trader. You buy them low and sell them high. Generally, there is a quick turn around measured in weeks or months at the most. This practice is commonly called “flipping” and is basically the practice of buying distressed properties, improving them and selling them. Since these properties are held for a very short time before being sold they are very seldom rented out. They are not really the assets of an investor as much as they are the inventory of a dealer.

Long term or cash flow properties are purchased for the money they generate in rental income. There are also tax benefits, but we’ll get into those another time. When an investor purchases a long term rental property, cash flow is king. The property has to bring in more money in rent than the cost of having it. If the property generates a positive cash flow, it puts money in the investor’s pocket each month after all the bills are aid.

When the market’s hot, some folks buy properties as rentals with negative cash flow speculating that values will go up so they can sell the property in a year or so and make money. What they have done is mix the concepts of long term cash flow and short term speculation. The result is that they have a long term investment that takes money out of their pocket every month and cannot be sold in the short term for profit. As I am sure you can imagine, this is not a good situation to be in.

My advice to you as the new investor is to keep it simple. Throw the get rich quick ideas out the window and buy properties that have positive cash flow. The rent money will come in whether property values are rising or falling and the next time we bump into each other you won’t have a problem in mind when you say, “I understand you’re in real estate.”