Rental Property Investing 101
Want to be a rental property owner? Here’s some good and bad news for you.
The bad news is that contrary to all the TV shows about flipping houses and people making money, or turn-key hassle-free rental properties, real estate is actually really hard work, it’s time-consuming and it is a pretty risky place to invest your money.
The good news is that most people, with hard work and determination, can earn a fairly substantial amount of wealth over their lifetime if they educate themselves and make better decisions when purchasing property.
Here are some tips that should help you earn real estate wealth. By the way — it’s a marathon, not a sprint.
Think long term (skip get-rich-quick schemes)
Long-term ownership is the key to real estate wealth. If you buy decent properties and hold them forever, that’s going to provide the highest likelihood that your real estate will have significant equity down the road.
Also, if it sounds too good to be true, it always is — especially in real estate. Drop the idea that there is fast and easy money to be made in real estate. It’s just not true. Sometimes people get lucky, but you don’t have to worry because that “lucky” person will never end up being you.
Cash flow positive properties
A significant portion of investors buy properties that are cash-flow negative or have very low investment returns. That means the buyer puts in their equity cash capital when they purchased the property, and they are still investing additional funds each month, which could go on for decades depending on how bad of a deal they purchased.
The better way to invest is to buy properties where the rents minus all the expenses, including the mortgage payment, provide positive cash flow that you can deposit in the bank. So if you collect $1,200 in monthly rent, then subtract expenses of ($400) and a mortgage of ($500) you will have $300 per month left over. Nice job!
Simple analysis tool: The 1 percent rule
A simple way to do a quick analysis is to take the conservatively estimated monthly rental income and divide it by the purchase price of the house. You still need to pencil out your deal with rents and actual conservatively estimated expenses, but this back-of-the-napkin test is a quick and easy test to see if it makes sense.
- Example of a good deal: If you can collect $1,600 per month in rent and you paid $200,000 for the property, you are collecting rent that is 0.8 percent of the purchase price (0.8 percent = 80 basis points in financial terms). And that’s probably a really fair deal.
- Example of a bad deal: If you can collect $1,600 per month in rent and you paid $400,000 for the property, you are collecting rent that is 0.4 percent of the purchase price, or 40 basis points. And that’s not a really good deal.
Find good quality properties
Smarter investors work hard up front to find the good areas where the rents provide a nice positive cash flow and investment returns, low crime rates, better schools, and decent amenities nearby like parks or retail. Coupled with good tenants who have excellent credit, you also create low vacancy rates.
Smart investors also buy properties that are in decent shape, although every property needs paint, carpeting and some plumbing and electrical work from time to time. Do that hard work upfront and spend the money to put your properties in very good shape, you’ll get a little more rent and probably have a bigger pool of interested tenants from whom you can then choose.
Lastly, do your homework, talk to other investors, read guides and books, shop properties, pencil out deals and have a long term ownership plan. Hopefully it will translate into a nice cash flow retirement picture.
- Buying? Use This Checklist to Avoid Surprises
- How to Pencil Out a Real Estate Deal
- What to Review in HOA Documents When Buying
Leonard Baron is America’s Real Estate Professor®. His unbiased, neutral and inexpensive “Real Estate Ownership, Investment and Due Diligence 101” textbook teaches potential real estate buyers how to make smart and safe purchase decisions. He is a San Diego State University Lecturer, blogs at Zillow.com, and loves kicking the tires of a good piece of dirt! More at ProfessorBaron.com.
Note: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinion or position of Zillow.