Landlord-Tenant EconomicsHow Landlords Make Money Off Tenants Rent At first glance, it appears that the only money made from owning rental housing comes from rent. In fact, only a fraction of the profit comes from this source. Using "other people's money" is the key to making money in rental housing. Rarely do landlords pay for a rental property entirely with their own money. Tenants buy it for them. Once they find a property to purchase, they find a bank to lend them the money. Even if a landlords had enough money to buy a rental property, they would not. Landlords only put a "down payment" on the house out of their own money, usually ten to twenty percent of the purchase price. A bank or other lending institution loans them the remainder of the cost in the form of a mortgage. Net Profit Mortgages allow landlords to buy more properties with less of their own money. More importantly, for tax purposes landlords deduct the interest payments made on the mortgage, along with other operating expenses, from the income they receive from the property. The tax system encourages landlords to take out mortgages since the "cost" of the mortgage (the interest paid to the bank) is deducted from taxable income. Here is an example of how this might work: Let's suppose a landlord purchased a house for $95,000 with $20,000 down. The mortgage of $75,000 was financed in equal monthly payments over 20 years at a rate of 11%. Here is what a balance sheet might look like for this house:
In this example, the landlord showed just $91 in gross profit from the house at the end of the year. This sounds too low, but this is only the beginning of the landlord's money-making scheme. Depreciation and Tax Deductions Landlords can depreciate their properties over time to reduce their taxes. Every year landlords can deduct a percentage of the purchase price of the rental building (not the land) from the total income they received on that property. This is a "paper" deduction that does not correspond to any actual expenditure on the property. It assumes that the building "wears out" over time and steadily loses value. Therefore, for the above example, the landlord might be able to depreciate 4% of the purchase price of the house in a single year. This would indicate a "loss" on the house even though the landlord actually made a profit:
The landlord is much happier with this paper $3,709 "loss" than she or he was with the measly $91 profit. Landlords do not want to show a paper profit (or gain) on each of their properties or all of their properties together. The more paper profits landlords show, the more income taxes they must pay. Many small-time landlords can deduct losses on real estate directly from non-real estate income such as wages and salaries. Larger landlords try to offset profits that they show on some of their properties with losses shown on others. Although large, wealthy landlords cannot deduct real estate losses from their non-real estate income, they can deduct their real estate losses from real estate gains. This allows them to avoid paying taxes. Investment Return In addition, landlords' mortgage payments are not simply a "cost" for them. They are buying the property over a number of years with the rent tenants pay to them. In the above example, after twenty years the landlord would own the $95,000 home completely, after investing only $20,000. If the landlord has managed to maintain a positive cash flow in the meantime, then this is just icing on the cake. Now that the landlord owns the building outright, she or he can sell it and pocket the $95,000, or continue to rent it out without having to make mortgage payments. This would give the landlord a net operating income in excess of $9,000 per year. Appreciation Ultimately, the biggest source of landlord profits is the appreciation of the property itself. Housing in Ann Arbor has been rising in value at rates in excess of 15% per year. This means that the value of our hypothetical landlord's house will have risen approximately $14,250 in one year. Thus, whatever small profit or loss may appear on the landlord's cash flow accounts, she or he will have made in excess of $14,000 on an investment of $20,000. As long as housing prices continue to rise at anywhere near current rates, landlords will be earning fantastic profits, regardless of what figures appear on their cash flow statements. Also, it is likely that rents will rise at approximately the same rate as housing prices, so that in future years our landlord will be charging higher rents for the house, even though the costs will not have risen as rapidly. In Summary: Tenants pay and landlords collect. Do not believe landlords who claim they are not making money. They would not be in the business if they were not making money. Supposed losses that landlords report merely disguise lucrative ways of making profits. Find Out How Much Your Rental Property Is Worth Step 1: Click on City of Ann Arbor web site To return to the Michigan Tenants Counseling Program web site, click here. Information, Not Legal Advice. We are providing this information as a public service. We try to make it accurate as of the date noted in the materials. Sometimes the laws change. We cannot promise that this information is always up-to-date and correct. We do not intend this information to be legal advice. By providing this information, we are not acting as your lawyer. If you need legal advice, you should contact a lawyer through your local legal aid organization. Always talk to a competent lawyer, if you can, before taking legal action. E-mail. Viewing this web site, or sending an e-mail message to the Michigan Tenants Counseling Program or other legal organization through this web site, does not create an attorney-client relationship between the Michigan Tenants Counseling Program or other organization and you. Sending e-mail to an attorney mentioned in this site does NOT create an attorney-client relationship between you and the attorney. Unless you are already a client, your e-mail may NOT be protected by the attorney-client privilege. Also, unless it is encrypted, e-mail can be intercepted by other people. Deadlines are extremely important in most legal matters. You may lose important legal rights if you do not obtain an attorney immediately to advise you. Many people do not check their e-mail daily, and some attorneys do not respond to unsolicited e-mail. Lawyer Advertising. This web site is not intended to be advertising or solicitation. Hiring a lawyer is an important decision that should not be based on advertisements. Before hiring an attorney, you should investigate his or her reputation and qualifications. Links. Some of the items listed here have not been prepared by us, but are instead "links" to information prepared and posted by others. We cannot guarantee the accuracy of information posted on other sites. The links are not intended to imply that we sponsor or are affiliated or associated with the people who created those sites, nor are the links intended to imply that we are legally authorized to use any trade name, registered trademark, logo, legal or official seal, or copyrighted symbol that may be reflected in the links. |
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