Rental property is a gateway to many great financial outcomes; you can use rental property to generate cash flow and make a steady monthly profit, or you can optimize your portfolio for long-term growth, capitalizing on appreciating home values in a chosen area. Depending on what angle you choose, you may invest in different types of properties, or focus on different areas.
How can you tell which decision is best? One important consideration is your investment time horizon. But what exactly is an investment time horizon, and how should it affect your rental property decisions?
What Is an Investment Time Horizon?
Let’s start with the basics. An investment time horizon refers to a period of time in which you expect to hold an investment. In other words, how long are you going to hold a rental property before you decide to sell it? More broadly speaking, how long are you going to pursue real estate investment; in other words, when are you planning to retire?
Why Choosing a Time Horizon Is Important
Choosing an investment time horizon is important for several reasons.
- Forecasting the market. First, your time horizon will dictate how you think about the market—and how important your forecasts are. For example, let’s say you’re predicting that there will be a short-term fall in real estate prices in a given area, but over the next 30 years, property values will significantly grow. With a short time horizon, this could be devastating if you make a purchase, but a longer time horizon will be much better able to tolerate this.
- Managing financial leverage. Rental property investment allows you to take advantage of financial leverage. This means you’ll be able to invest using borrowed funds, rather than your own capital. It’s a great way to increase your total potential gains, but it also carries additional risks. Your investment time horizon will help you calculate your current risk tolerance, with longer time horizons tolerating risk much better. In other words, better understanding your time horizon can help you better manage your financial leverage.
- Balancing cash and equity. Your time horizon can also help you decide how to balance your liquid and illiquid assets, such as your cash and equity. How much cash do you need to keep on hand, and how much equity are you willing to build?
- Justifying improvements and renovations. Let’s say you have a rental property where you can earn $1,200 in monthly rent. You’re considering spending $25,000 on a kitchen and bathroom renovation, which could help you collect $1,500 in monthly rent instead. Increasing your income by $300 per month yields an extra $3,600 per year, which means it will take you just under 7 years to fully recoup your investment. Your time horizon can help you decide whether this is an acceptable tradeoff; if you’re investing with the intentions of holding the property for 30 years, 7 years is a completely reasonable time to make back your money.
- Mitigating risk. Every rental property investment comes with some risk, but your risk tolerance will depend on your time horizon. If you’re interested in getting out of the game fast, you won’t want to take big risks. But if you have many years to make up for mistakes and invest in different areas, your risk tolerance is much higher, and you can afford some riskier plays.
- Choosing an endgame. Regardless of what your time horizon is, you should use it to come up with some kind of an endgame. Are you hoping to use your rental property portfolio as a way to generate income in retirement? Or are you interested in selling your properties once you reach a certain point, using the funds for something else? There are no right or wrong answers here, but your time horizon and long-term goals can work together to help you create a solid vision for the future.
What Are Your Goals?
If you’re not sure what your time horizon should be, consider your goals in rental property investment.
- Short-term gains. Are you interested in using real estate as a way to make money in the short term? For example, are you interested in flipping a few properties so you can get access to cash? If so, you should aim for a much shorter time horizon.
- Cash flow. Some people want to optimize their rental property portfolio for cash flow. This could be a way to increase their total monthly income, or as a means of funding their retirement with consistent, predictable profitability. Either way, cash flow-focused strategies tend to work best with a mid- to long-term time horizon, so you can maximize your potential revenue stream.
- Portfolio development. If you’re hoping to keep most of your money in real estate, you might be interested in building a full rental property portfolio, with many different properties in different areas. It takes a long time to build this kind of empire, so it’s not something a short time horizon can help you accomplish.
- Long-term gains. You may also be interested in optimizing your investments for long-term gain. In this scenario, investors heavily favor low-cost properties in neighborhoods that are poised for growth in the next several years (or decades). Naturally, this is a strategy that benefits from a very long time horizon.
Setting a Time Horizon for Yourself
Your time horizon doesn’t have to be exact—for example, you don’t have to know the exact month and year of your retirement—but you should have a general idea of how long you plan to invest in rental properties, long before you begin. Think carefully about your goals, your current position, and your personal preferences, then use your time horizon as a basis for your investment decisions.
Managing even a single rental property can be challenging for an inexperienced investor. That’s why it pays to work with a property management firm like Green Residential. If you’re new to the property investment world, or if you just need help deciding how to manage your Houston properties, contact us for a free consultation today!