After equities and bonds, real estate is probably the third most popular asset class to invest in. There are two ways to invest in real estate: Be an Active or a Passive investor. Each comes with its own set of benefits and shortcomings. Then there are multiple ways to be an active investor as well. There is rental property investing for income and appreciation and flipping a property for quick capital gains. Although many investors find success in flipping real estate, we believe rental property investing provides long-term benefits both for investors and society at large.
Why we love rental property investing so much?
It provides a sustainable benefit to society.
People will always need a place to live. Unfortunately, major cities fail to provide their residents with enough housing. It is not 100% their fault, however. Many cities have experienced unprecedented population growth due to urbanization, immigration, and business positioning themselves in larger metropolitan areas. Add to that the fact that qualifying for a mortgage becomes more difficult. Then there is a cultural shift that values flexibility and mobility more, so the demand for rental properties will only increase over time.
Yield is easy to calculate and sustain.
It is relatively easy to calculate how much you will be earning from your investment property.
Yield = Annual Rent / Value of the property.
Although the formula can get more complicated once you start factoring in vacancy rates, maintenance costs, and so on, it is still easier to control than the dividend yield of your equity investments, for example. The reason is that you are in full control.
You are in total control.
Unlike being a passive investor in real estate, where somebody else handles everything for you, rental property investing means you own the property and thus control all the numbers. Income & costs are your responsibility. They are not difficult to figure out and, most importantly, sustain over a long period.
You don’t need much cash to buy an investment property because you can borrow from the bank and use someone else’s money to increase your return. This concept is known as leverage. Leverage increases your return, but it also exposes you to more risk. Leverage is a multiplier, but it works both ways. You multiply your gains but also multiply your losses if they occur.
Ability to directly influence your investment
There are clearly defined activities you can perform to improve your investment return. You can renovate the property to charge higher rent. Find a better mortgage rate to save on interest. Negotiate a better deal. Choose a smaller or bigger down payment. You can continuously add features to the property to improve yield and its value. This goes back to the point of control. You don’t entrust the board of directors or the CEO to make all the right decisions. You are in charge.
Income is passive.
Rental property investing generates passive income. Once you set everything up, your income doesn’t require you to be present 100% of the time, unlike a regular job.
It is not a new investment idea.
People have done rental property investing for an incredibly long time, and the internet is full of great resources to get you going.
What are the downsides of rental property investing?
It requires a lot of work.
Although an obvious point, it is often missed. To make your rental property successful, you have to analyze it to the bones. You have to account for risks and ensure you have enough reserves set aside to handle all the bad things that inevitably will happen.
Dealing with tenants can be stressful.
Unfortunately, not everybody will be easy to deal with, paying tenant. Some people will be tough to the point where legal action might be required. This is stressful emotionally and financially.
Leverage increases your risk.
As mentioned before, using leverage in the form of a mortgage increases your risk when something goes wrong. Banks will always collect their share even if you can’t pay for whatever reason, your tenants can’t pay, or the property’s value goes down.
Physical assets break down.
Because you own a physical asset, it is prone to all sorts of damage. For example, pipes bursting, heaters breaking, air conditioners stop working, faucets leaking, and so on. It is your responsibility to deal with it. You will hire somebody to do that for you, but it does cost money. These costs need to be accounted for in advance, adding more to your initial workload.
What do I need to get started?
Unlike buying a stock portfolio, you can’t purchase a rental property with a click of a button. We mentioned that it takes work. And the most significant chunk of that work will be financial analysis. Before jumping into a cash flow analysis, make sure to get the basics down.
Basics Step 1. Figure out your budget
Do you have enough startup capital to put enough money down on a property? What can you afford, given your budget, in your area? Remember that you will likely have to visit your rental property throughout, so it needs to be a reasonable driving distance from where you are.
Basics Step 2. Does the high-level cash flow calculation make sense?
Without digging too deep into your potential income and expenses, do rough math.
Your monthly Cashflow = Rental Income – Expenses.
Do you end up with a positive or negative number? It is okay if the number is low. Remember that you will be building equity and paying off your mortgage loan with rental income no matter what. However, there will be unexpected expenses and months where income is zero, so you have to make sure numbers make sense before proceeding.
Where do I get real estate market information?
You have to research your particular market. No one resource will have all the answers for you, but here are solid tips where you can get all the information
1) Google: “Average rent price for [#] bedrooms in [City/Neighborhood].
2) Read those real estate flyers that everybody throws out. They are free, and you can find them in the junk bin in any building.
3) Complimentary newspapers will have a real-estate section. Don’t skip those.
4) What sites do people search to find rent in your area? Every city tends to use different sites. How did you or your friends find a place to rent? Go to those sites.
5) MLS sites. There are too many to list here. Popular ones include realtor.com, zillow.com, Trulia, and many others.
6) Talk to other landlords
7) Browse local forums. Rent information is typically straightforward to find for your specific area.
Final thoughts & Next Steps
Once you know your budget, rough numbers for the area you want to invest in, the next step is to dive in and figure out if rental property investing makes sense in your particular case.
We do this by doing a deeper cash flow analysis, trying to capture as many moving variables as possible to come up with realistic projections of profitability.