Maybe you have been planning and saving for years, and the time is finally right. Maybe you have come into a sudden windfall and are looking for a wise way to invest your newfound wealth.
Whatever your situation, real estate is an excellent investment option. Invest wisely, and your rental properties will earn you steady, passive income for as long as you keep them rented out. Real estate can also be a smart long-term investment if your property appreciates in value over time.
So the “why” of investing in real estate is straightforward, but what about the how? What does a prospective landlord need to know about buying property, and of managing their properties efficiently and profitably?
First Things First: Find the Right Rental Properties
Before we start counting our profits, let’s concern ourselves with what makes a good property for rental.
There are a number of variables that need to be considered, and a miscalculation could result in headache after headache. Worst-case scenario, you might well end up watching your investment burn up right in front of your eyes, even selling off your property at a loss!
To prevent such a tragedy, keep the following rules in mind:
Buy at the Right Price
A rookie mistake is to pay market price. Just buying any house at any price is a sure way to end up losing money. You need to weigh the price you pay against the potential rent you can extract from the property.
And to do that, you need to find the bargains.
When is the Price Right?
As a rule, the amount you pay should be no more than 80% of the property’s value after you have repaired it. So beyond the actual price of the home, this means you also need to account for the closing costs and the estimated cost to renovate it. The former should be fairly predictable, but the latter is where many prospective landlords get into trouble.
Whatever you expect it will cost to renovate, over-estimate that figure. It happens all the time that there is some unforeseen issue that you could not have predicted. You need to hope for the best and plan for the worst.
You need this final figure to be 80% under the property’s projected value because you are going to need that equity the first day you own the property. The reasons are threefold:
First, that equity can help you start building wealth right away and provides a healthy safety cushion for your endeavor.
Second, 80% of the value is generally the amount that a lender will let you refinance out of your property. This way, you could feasibly refinance your initial investment out of the deal.
Third, that 20% margin improves the chances that your rental income will exceed your monthly expenses. We’ll come back to that after we finishing picking out our investment property.
Finding the Right House
Price is the principal concern, and a major influence on the price will be what type of house you choose to invest in. In general, this is going to mean eschewing older homes in favor of more contemporary options.
Old Victorian homes or homes with expensive, tiled roofs may look lovely, but they can be an expensive nightmare to repair and maintain. To maximize your profits, you want a home made out of standard materials where everything like the plumbing and electrical elements is easy to access.
Landscaping is another area where simplicity pays dividends. Try to limit it to a nice lawn, a couple of flower beds, and ideally a patio. You don’t need to tend to cement after all, so that means less upkeep for you and your tenants.
Buy Close to Home
A good rule is to buy a rental property no more than 20 minutes away from home.
The problem is that an absentee landlord will usually take longer to find out about problems on the property. This can lead to small problems like moisture in a basement turning into an expensive problem like a flooded basement.
Whereas a local landlord could have gotten a failed sump pump fixed or replaced right away, one who lives an hour away never got around to checking on it until it became a catastrophe.
So you’ve settled on a nearby property that suits your specifications and your budget. Now to make some money off of it. Which brings us back to that 20% margin we looked at earlier.
As discussed, that number is not a hard and fast rule. Depending on the mark and the rents in your area, you might be able to get away with less than 20%, or you may need to plan on a significantly higher one.
But that’s not the only percentage to consider. Having equity won’t save you if you can’t make the monthly payments on the property. You need to get the cash flowing in quickly and at a sustainable volume.
At the minimum, the monthly rent needs to be at least 1% of the total price you paid for the property, and preferably closer to 1.3% or higher. Remember that any rent you collect is going to be taxable, so you need to plan on that as well. It would also behoove a first-time landlord to familiarize themselves with some of the deductions for which they’re eligible.
An Alternative Strategy
Okay, so this is starting to sound like a lot of work and not much of a guarantee of return on investment. Well, there is an alternative.
Prospective real estate investors can invest in what’s called a Delaware Statutory Trust, or DST. It’s basically an arrangement established under Deleware law where the investors all own an undivided interest in the trust, and the trust, in turn, owns and manages the associated properties.
There are some financial benefits to the arrangement like deferment of capital gains taxes, and investors with limited funds can buy in for a fraction of the price of a full property.
If that seems more to your liking, you should learn more about DST’s.
Is Real Estate Worth It?
Despite being a more involved investment than trading stocks, the overwhelming consensus still seems to be that rental properties are about as reliable of an investment as you’re likely to find. It’s just going to take some work, and like any investment, the right knowledge to make a profitable decision.
Check out our other articles for more tips on how best to manage and invest.