Note this post is about rental properties – not about consulting. That said, all consultants and professionals making $$$, need to start putting money away to get yourself retired? It’s actually a question that I ask most all of my friends, and even acquaintances: “What are you doing to get money working for you (assets) so you can get yourself retired?” The level of financial literacy in the United States is LOW, and honestly, it is about getting assets on your balance sheet working for you. I would argue it’s more important that you have assets earning 10%+ ROE, than it is getting at 10% raise.
Income statement is the beginning, but balance sheet is the real game.
I invest in real estate rental properties. I am small-time vs. other investors, but want to walk you through some of the math and simple tips.
Rental properties which cash-flow make sense:
- Money is very cheap, current rates are 3.25-3.75% for a 15 year fixed mortgage
- US Banks will loan you 3 to 1. You only have to put down 25% down payment
- Real estate varies, but if you are crafty, you can get 1% of the purchase price in monthly rents. 1% monthly x 12 months = 12% of the purchase price annually.
- Real estate is tax advantaged. Depreciation creates accounting expenses which reduces your tax burden today. Yes, cost basis goes down, but you can always use 1031 transfers (advanced topic) to keep postponing the capital gains.
- It’s an imperfect market – every property is different, and sellers have all kids of different motivations (marriage, divorce, inheritance, job transfer, bankruptcy). As a long-term investor, volatility is your friend.
Get 10%+ ROE. If you buy smart, and manage properties yourself in non-metro areas, you can get return-on-equity of 10%+. Since bank CDs are paying 1%, and the stock market is crazy unpredictable, that is a great return. The math might looks like this.
- Buy house for $185K, put down 25% downpayment (~ $50K); in my market that buys you a 4bed, 2.5bath 2,600+ square feet. (remember, suburbia)
- Put in an extra $25K in fix up for a total of $75K ($50K + 25K)
- Rent out for $1,700 a month
- Pay mortgage (15 year) with 3.25% rate for monthly payment of $1,300 (includes taxes and insurance)
- Monthly cashflow is $400 ($1700-$1300), and equity build up (amortization) is about $500.
- Total return is $400 (cashflow) + $500 (equity from debt pay down) = $900
- $900 x 12 months = $10,800
- $10,800 net income / $75K invested = 14% return on equity
- Note: there may be other expenses – toilets break, 2-3 weeks of vacancy while you fix it up, small things here and there
- Note: this is not financial advice, just an illustration
1. Location, location, location. Convenience is key. Access to highways and proximity to jobs matters. Good school districts. In the US, there is a real estate website called Zillow which has the informal ratings of schools from 1-10. If you buy in a market where the schools are 9-9-9 (elementary 9, middle 9, and high school 9), tenants with school-age kids will love this property.
I live in a top 10 US metropolitan area. I invest in the suburbs. . 30-40 miles from the airport, so this is not Manhattan, downtown San Francisco, or even metro LA. This is the suburbs; more likely to find a movie theater than a tourist attraction. Get a property that is has lots of space, bedrooms, and is friendly for pets.
2. You make money when you buy. This is a real estate adage because you cannot predict the price that you will get when you sell. Very cyclical, and stupid to count on capital appreciation. As for as I am concerned: cash flow is like a dividend paying stock. Hoping for capital appreciation = speculation; not smart. That is how you lose money.
3. Set up some criteria. Obviously, do the research. Figure out what you want to pay for your target house (location, neighborhood, # of rooms, # of bathrooms, $ per sq ft, relative age, estimated monthly rents). Watch the market for a few months and get smart on the market. Listen to bigger pockets and read some books. Read, damn it, read:
- Millionaire Real Estate Investor, Gary Keller
- Book on Rental Property Investing, Brandon Turner
- What Every Real Estate Investor Needs to Know, Robert Gallinelli
- Building Wealth, One House at at Time, Jon Schaub
4. Put in an embarrassingly low offer. This is advice from the pros. I don’t go this far – but the point is the same. Put in low bids because it is okay to not get the property. More “At-bats” is better. Don’t get buyers’ remorse. As an investor, you job is to get great deals because you are not desperate. You are not a residential buyer. . your daughter is not going to the school. Emotions don’t get in the way. This is a numbers game + some judgment.
5. Get a great rate. Use a broker – not a dedicated loan officer from a big bank. Get someone who can shop around rates. Interest rates have been historically low for 8+ years. This will not last. Although this goes against Dave Ramsey, I say get smart leverage. It works for Goldman Sachs, and Warren Buffett. If you get 3.5%, you are a champ.
6. Don’t over-do the remodel. It’s common for newbies to overdo it on the fix up. They put in fixtures and finishes which are unnecessary, expensive, and worse, gaudy. They make the B-class property fit a peculiar A-class taste. In most cases, you are targeting a Honda Accord / Toyota Camry taste. . not a Tesla X / Audio A7. This is an experience curve because when you start – you will pay retail for everything. . tiling, hardwood, painting, landscaping, plumbing etc. . it is a learning curve.
In the following picture, you can see what new appliances, granite countertops, lighting, fixtures and paint can do. All doable.
7. Market like crazy. Some people put signs in their yards and hold open-houses. I recommend postlets.com. It blasts out your property to the top 3 rental sites: Zillow, Hotpads, and Trulia. Craglist works too. Put a spare key on a lock box here (affiliate link) Take some great pictures and keep the house presentable – good lawn, tidy inside.
8. Keep your privacy. Get a PO Box. Get a Google Voice account. You do not know people to know your cell phone or your home address. Remember, there are crazies out there. Always be smart, meet candidates during the day, do not accept cash. Don’t be stupid.
9. Screen tenants. Be picky. There are tons of laws on what you can / cannot do. Read NOLO books here (affiliate link). They are written by lawyers, but for laypeople – like you and me. Make sure the tenant has gross income of 3-4x the monthly rent. People without enough money to pay rent will make bad decisions. Meet the candidates and get a feel for their character and affability. You want easy-going, low-maintenance people. . . who are also neat, responsible, and looking for a good landlord.
Get a good contract. Like a good SOW, clarify all expectations and consequences of non-compliance. If you are in this business long-enough, unfortunately, you will go to court for an eviction. The contract is a key instrument in your favor.
10. Be a responsive landlord. Being a landlord is not easy, nor is it impossible. Be responsive to problems, but treat them like employees, not customers. Set them up for success with clear expectations, and coaching. Be fair and firm. Set guidelines, and be practical. Read up on tips and tricks:
Steps 11-20 in a following post.
- How to handle repairs
- How to move trouble tenants out
- How to get more loans for future properties
- How to protect yourself from liability
- How to defer taxes for a long time
- When to determine to sell/buy more properties
- How to stay smart on the topic of rental properties
Note: all books were affiliate links. Note: The content of this post are observations of the writer. For any legal, financial, or tax questions, consult a paid-professional.