Asset Focus: Rental Properties
Let’s face it, everyone knows there’s good money in real estate investing. For income investors, rental properties generate monthly income from rents and lease payments. But not everyone should become a landlord. Here’s my quick one-stop guide to investing in rental properties for monthly income.
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- What is Rental Property Investing
- Investment Strategies
- Buying Your First Rental
- Assessing the Deal
- Finding the Money
- Managing Your Rental Property
- What are the Risks
- Conclusion and Resources
What Is Rental Property Investing?
In a nutshell, rental property investing involves the purchase of a piece of real estate with the aim of leasing it to a tenant. Simple, right? Well, there are many wonderful things about owning rentals, and monthly income is certainly one. But there is a heck of a lot for the budding landlord to learn if you are to make a success of it.
First things first, let’s clear something up that I think is desperately important. Investing in rental properties will NOT provide you with passive income. If you want a ‘hands off’ low maintenance type of real estate investment you should buy shares in a REIT, or invest via a crowdfunding platform. Maybe even buy a performing mortgage note or become a private lender.
Successful landlording takes a lot of time, energy and resources. This is especially true at the start of your rental investing journey. You will need to build trusting and mutually beneficial relationships with a ton of professionals that will be involved in almost every deal you do. These include:
- Building Inspectors
- Contractors of all types
- Title Companies
- Property Managers
- Banks and Mortgage Brokers
- Private and/or Hard Money Lenders
The list goes on. But before you even consider finding people to work with, there are few things you need to get straight. First off, you need to pick a strategy for investing in rental properties that suits the amount of time and budget you have.
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Strategies for Investing in Rental Properties
One of the best things about rental properties is that you can borrow some, or sometimes all of the money to buy them. This use of leverage makes real estate especially attractive because you can generate income and capital appreciation from a large asset by putting in only a small part of the money.
One of the most popular rental property investing strategies is the BRRRR method. This stands for Buy, Renovate, Rent, Refinance and Repeat. Put simply, you buy your first rental property, add value through repairs and renovation, rent it to a tenant, then refinance it to release the equity to put down as the deposit of your next rental.
Of course, there is a lot more to it than that. But following this fairly basic concept has allowed thousands of investors to build sizeable rental property portfolios with relatively little of their own cash invested. But first, you need to get started with your very first rental property. Here’s how…
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Buying Your First Rental Property
There are lots of things to take into account when figuring out exactly where to look for potential rentals. Most investors will start out with a single family home or small apartment building in their local area. Being close to your rental property allows you to take control of the purchase process, project management of any subsequent renovation work, and property management.
Some other factors to consider include home value trends, crime rates, employment figures and well-rated schools. But maybe your local area doesn’t support the rental investment model. Perhaps house prices are too high, or rents too low, or both. Or maybe there are just not enough suitable properties for sale locally. In that case you will have to look further afield.
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Long Distance Rental Investing
It is quite possible to invest in real estate long distance. I do this all the time. If this is what you want (or need) to do, there are plenty of companies geared up to provide prospective investors with ‘out of State’ turnkey rental properties, or project-managed BRRRR investments.
Wherever you choose to invest, there are many places to find potential rental properties for sale. I often find deals on the MLS, or you can try to find off-market deals yourself, or through a wholesaler. There are tons of books and courses on finding investment properties to buy, but be careful what you pay for as all of the information you need is out there for free in the public domain already.
Once you have found a good rental market and a potential rental property to buy, you need to be able to assess the deal and make sure it stacks up. Will this house generate sufficient rents to provide you with net monthly income after the cost of ownership and management?
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Assessing Your Rental Property Investment
There are always lots of moving parts in this process. Assuming you have found a potential rental property for sale, there are a few basic calculations you can run to help get a sense of the viability of the deal, especially in terms of cashflow.
Ultimately, you need to figure out whether the rent you receive will be enough to cover the ownership expenses, and provide you with a profit on top. These expenses include your mortgage loan principal and interest payments, property taxes, property management, insurance, and the cost of repairs and maintenance.
Let’s look at the theoretical purchase/renovation of a single family home for $100,000. This includes the property purchase price, closing costs, estimated cost of renovation and short-term financing costs. Let’s further assume you intend to use $30,000 of your own money, a hard money loan, and then refinance with a $70,000 capital and interest mortgage loan with an interest rate of 5.25%.
On the assumption that this property will rent for $1,000 per month, the basics calculation for this deal might look like this:
- Monthly Mortgage Payment: -$386.54
- Monthly Insurance: -$50
- Property Taxes: -$150 (monthly pro-rated)
- Property Management Fee: -$100
- Reserve for Repairs: -$100
- Total Monthly Cost: -$786.54
- Monthly Rent: $1,000
- Monthly Cashflow: $213.46
So this looks like a great deal, right? Well, it certainly cashflows well on paper. But there is always more to every deal than this very simple set of numbers. You also need to think about other variables that can impact your cashflow such as vacancy rates and other unexpected costs. In my experience it is always a good idea to keep some extra funds in the bank in reserve ‘just in case’.
A couple of things to note here. Firstly, we’ve assumed you’ve added some value to the property with your renovation. Assuming it is now worth $130,000, you’ve made an on-paper equity gain of $30,000 – effectively doubling your cash investment from day one.
This being the case, many investors will actually look to get a mortgage for the full $100,000. This will repay their $30,000 investment so they can repeat the process and buy their next rental. That’s the BRRRR method, and why it’s so important to buy cheap and add value to make the model work!
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Finding the Money and Financing the Deal
Based on our previous assumptions that you are going to add some value to your rental property, chances are you are not going to secure traditional mortgage financing in time to close on the deal. Often when we are investing in rental properties we are buying at a discount, and need to pay cash at closing.
So where do we find the money? Well, we are already assuming we have $30,000 in our own cash, but some of that will be used for renovations. So let’s say we have $10,000 in liquid capital of our own. The rest of the purchase money will most likely come from a short term funding source such as a hard money lender or private lender.
A hard money lender is a professional real estate lender who makes short term loans to real estate investors. A private money lender is a private investor who loans you the money. You will typically use one of these short term loans to buy the house, your own money to renovate it, and then a bank mortgage to refinance and pay back the short term loan after the property is renovated and rented.
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Managing Your Rental Property – What to Expect
Congratulations, if you’ve got this far then you now own your first rental property. And if you’ve done it right, you also have all your own cash back in the bank. Now you have to manage the property and tenant.
Some investors manage their own rental properties. Personally, I hand this process over to a licenced and insured property manager. You do not want to find yourself in court because you didn’t file a certain form at the right time, or follow a particular protocol when dealing with tenants, utilities, insurance or repairs.
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What are the Risks?
As you can see, investing in rental properties is not exactly easy. There is a lot to learn, and a lot can go wrong. You may have repair and/or damage problems, tenant problems, even neighborhood problems. All of these things can and do happen, and can seriously impact both your cashflow and time.
One of the biggest risks in my experience come during the renovation process. Renovations can run wildly over budget after a project gets started and you start to uncover more issues that may not have been apparent during your inspection. You may also have issues with the quality and/or cost of work and/or materials. Not all contractors have your best interests at heart!
If you get through the rehab relatively unscathed, another area of concern is your refinance loan. If you have used hard money or private money to purchase and renovate the house, you need to be certain you can secure mortgage financing to pay these back.
You then have all of the standard issues that come with rental property investing. Bad tenants, or no tenants at all, property damage, bad management, poor work from contractors. The list is potentially endless! But perhaps the biggest risk of all is taking on thousands, even millions of dollars in mortgage debt!
With all that firmly in mind, investing in rental properties is one of the best ways to invest for monthly income, and build your long term wealth. I own over 80 rental properties right now, and doing so has given me the financial freedom to spend time doing the things I love, and not stuck at a desk grinding 9 to 5.
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Conclusion and Resources
Informed investors make better decisions. If you want to learn more about investing in rental property and other investments that generate monthly income, you can further your research using the following resources: