Real estate investing

The pro forma, with nothing left out

The whole property, monthly: $300,000 purchase, 25% down ($75,000), a $225,000 loan at 6.5% over 30 years, market rent $2,300.

Payment computed as a standard amortizing 30-year loan. Tax, insurance, and rent ratios vary enormously by metro; substitute your own and the structure holds.

What the beginner version omits

The social-media version is rent minus mortgage minus tax minus insurance: $2,300 - $1,422 - $300 - $125 = $453. Every number is true. It is still wrong: it assumes the unit is occupied every night, nothing breaks, the roof lasts forever, and you work for free. Vacancy, maintenance, capital expenditure and management are not costs you might avoid; they are costs already incurred and not yet billed. A furnace does not get cheaper because you failed to budget for it. That is the entire gap between $453 and -$117: $570 a month of expenses that arrive irregularly, which is exactly what makes them easy to leave out.

The 1% and 50% rules are filters, not valuations

The 1% rule says monthly rent should be at least 1% of purchase price. On a $300,000 house that is $3,000 a month; the property above rents for $2,300 and fails. The 50% rule says operating expenses excluding debt service run about half of gross rent; here they run $995 against $1,150, close enough to confirm the pro forma is not fantasy.

Both are screens for deciding which listings deserve an afternoon, not methods for pricing an asset. The 1% rule is essentially unfindable in high-cost metros, which is the most useful thing it tells you: in those markets buyers are not paying for cash flow. They are paying for appreciation and accepting negative carry to get it. A legitimate bet — just a different one from what the beginner spreadsheet describes.

Four sources of return — and the lever under all of them

Rental returns come from four places; cash flow is only one. Year one on the property above, with roughly $84,000 of cash in ($75,000 down plus about $9,000 of closing costs):

The fourth source is tax treatment. Residential rental buildings are depreciated over a 27.5-year recovery period; land is not depreciable, so on a $300,000 purchase with 80% allocated to the structure that is roughly $8,727 a year of paper deduction against rental income, sheltering cash you actually received. It is a deferral, not a gift: on sale, depreciation recapture claws back the benefit at its own rate. Confirm current treatment first.

Look again at that 10.7%. The property appreciated 3%; your cash appreciated 10.7%, because $225,000 of the asset was bought with someone else's money. That multiplier is why a 12% year is available on an asset that moved 3%, and it is the whole reason real estate turns modest savings into large net worth.

The arithmetic does not care about direction. A 3% decline is -10.7% on your cash. A 10% decline erases about 36% of it, and the $225,000 mortgage does not shrink to keep you company. Add a vacancy in the same quarter and you are funding the payment out of savings — which is why a rental belongs behind a fully funded emergency fund and after any high-interest balances are cleared, not before. Leverage is the reason this asset class makes millionaires and the reason it unmakes them.

The job you just accepted

This is a part-time job. Tenant screening, lease compliance, a plumbing failure at 11pm, a turnover meaning paint, carpet and three weeks empty, eviction law that is local, slow, and unsympathetic to your spreadsheet. One property is manageable. Four is a business.

You can buy your way out by hiring management, which above costs $175 a month — more than the entire cash flow line. Self-manage and the property clears +$58 instead of -$117. That is the honest trade: the gap between a rental and a hands-off investment is roughly 8% of rent, and once you pay it what remains is a leveraged, illiquid, single-address bet. Where that sits against stocks is a question for asset allocation, and how it ranks against other income streams belongs on passive income.

REITs: the hands-off version

A real estate investment trust owns income-producing property — apartments, warehouses, data centres, medical offices — and is required to distribute the large majority of its taxable income to shareholders. You buy it like a stock. It is liquid, diversified across hundreds of buildings and several metros, carries no leverage of your own, and nobody calls you about a water heater.

The trade-offs are real. You give up the outsized leveraged upside, you give up the depreciation deduction, and REIT distributions are generally taxed as ordinary income rather than at qualified-dividend rates — which is precisely why a REIT allocation belongs inside a 401(k) or Roth IRA where the distinction stops mattering. A broad total-market fund already holds REITs at market weight, so anything beyond that is a deliberate tilt; the base case is in index funds.

For most people building toward $1,000,000, that is the answer: a modest REIT slice in a sheltered account, on top of the boring core described in investing. Buy the actual rental when you want the leverage badly enough to take the job attached to it. Run your own arrival date through the millionaire calculator before deciding the rental is a shortcut.

Educational content, not financial, tax, or legal advice. Figures are illustrations based on stated assumptions, not guarantees; markets involve risk, including loss of principal.