What is better, notes or rentals?
If you’re like most investors, you have a renewed perspective on your business right now. That’s because you’ve just analyzed all your rentals, done an inventory of your cash flow and have gotten things ready to send to your CPA. We call this process our end-of-year review.
During this process you’re seeing what kind of cash flow your properties actually brought in. The reason I say “actually” is because cash flow is an ever-changing thing that is rarely what you thought it was going to be when you first bought the property. Property taxes, insurance, vacancies and repairs are the cause of this variability. And as those values go up and down, so will your annual cash flow.
This end-of-year review is super-important because it gives you an opportunity to see how your houses are performing. During this process you may find that a house you thought was an amazing deal really has a negative cash flow because of all the repairs you had to make.
We’ve also experienced the opposite. After evaluation, we’ve discovered that one of our rentals we thought was an underperformer was actually one of our best houses in terms of cash flow.
In addition to looking at your rentals, you need to evaluate the notes you have after selling a house with owner financing.
Notes are a wonderful thing because the cash flow on them is not affected by expenses associated with rentals. There are no property taxes, repairs or insurance associated with them. The only “vacancy” you can have is a missed payment.
So, when you’re depending on consistent cash flow to live off of, notes become very attractive.
One of the drawbacks to notes, however, is that one day, they will be paid off. This fact is something you need to make a note of (pun intended) during your yearend review.
This year, we had five Lonnie Deals to pay off. If you don’t know, a Lonnie Deal is where you buy a mobile home on a rented lot for cash. You then resell it with owner financing in which you get $1,000 down and payments of $300 a month for 42 months.
Since our normal Lonnie Deal pay us about $300 a month, that means at the start of this year we have $ 1,500 less in monthly income from our notes than we did last year.
Ouch – $1,500 a month is a lot of grocery money gone!
On our rental properties, however, all of our rates have increased. We have had very low turnover and have filled vacancies mostly on our new acquisitions.
So, with these scenarios in mind, what would you rather have: notes or rentals?
The answer to that question is that you should have both. You see, there are advantages and disadvantages to any investment strategy. The biggest advantage with notes is they provide consistent cash flow. The disadvantage is when those notes eventually pay off, that dependable income stream stops.
Rental properties come with the advantage of providing income as long as you have a good tenant in place who’s protecting and paying for the property. There are also tax advantages associated with rentals, like depreciation, that you don’t receive from notes. But houses need repairs. And even though house values and rents tend to go up, so do your taxes and insurance. These ris- ing costs chip away at your monthly income.
So, as you ask yourself which income stream is better, realize you need both for a complete portfolio. As notes are paid off, your rental income fills the void. But when you have vacancies and repairs on your rentals, you can count on the consistency of your note income.
With that in mind, Ashley and I need to get to work replacing that $1,500 in lost note income. That reminds me, does anyone have a mobile home for sale?