Today’s posting is on investing in rental real estate. Since the market has turned around in many parts of the United States, many people are considering getting back into the real estate market. Since rental properties are a proven way to build wealth, this post addresses two important aspects of rentals: making money* and management.
First off, a rental property is “profitable” if you are covering your expenses – that is you are able to build up a cash reserve and can achieve at least a modest profit (5 to 10% pretax). Since the money is the whole point, here are some ways to profit from rental real estate.
1) Buying in a Low Priced State: If you buy into a low priced state, the rents may be more likely to cover your expenses. For example, in Oregon, where we’re from, the housing market wasn’t as frothy as it was in other parts of the country. Because of this, housing prices are lower in Oregon, so its easier to buy profitable rental properties.
2) Buy in Working Class Neighborhood: In some neighborhoods in some cities, you can still purchase a profitable rental. An important consideration here is that sometimes working class and minority communities attract renters who have less than perfect credit. You’ll need to plan accordingly.
3) Buy a House with a Problem that Traumatizes the Seller: The main idea here is that if you buy a house that’s got problems (e.g. a bad foundation, leaky roof, homicide occurred on premises), you’ll have better bargaining leverage and might be able to purchase the property at a discount. The thinking here is that sellers may be more motivated if they think their place will be hard to unload – thus increasing your ability to bargain hard.
4) Buy a one bedroom Home: These are hard to find, but they sell cheap because most homeowners are looking for more space. On the other hand, they can command good rents because many renters are singles or childless couples. If the house has enclosed space you convert it to a second bedroom.
5) Buy a House with Extra Land: If you can pick up a place with more land than the zoning laws allow, you can subdivide the land and sell it to a neighbor. Even if you have to go through a formal subdivision, the cash windfall might turn your rental property into a winner.
6) Rent With A Option To Buy: The main idea here is to put an option to buy in the contract owners sign with their tenants. The terms of this “option to buy” contract usually involve the tenant paying a higher amount of rent than the market currently bears, with the understanding that the higher amounts will be credited towards buying the property at the end of a specific term. For example, if the normal rent is $900, the lease option payment would be $1,300. The tenant would pay the $1,300 for a specified period of time, at which point they would have the right to buy at price specified in the contract. Option to buy leases can be complicated, so get a competent attorney’s advice before going forward.
Now, once you’ve got a rental property, you need to develop a logistical and support network to manage the property. Things to consider include:
1. Forms and Paperwork: Typically this means a rental application, credit check authorizations, legally mandated disclosures, payment receipts, or other forms. Look on-line for boilerplates or talk with your realtor or attorney to get help.
2. A Lawyer: Yes, its true. Lawyers are sometimes necessary. In many parts of the country rental markets are highly regulated. You’ll often need a good attorney to advise you on sound strategies for motivating slow paying tenants or for buying and selling larger multifamily buildings where there are leases or other legal complexities.
3. An Account System: If you have rental real estate, you should probably get a separate bank account for your property. This would include a checking account to handle transactions and a savings account to stash your house emergency fund. Its best to get these configured so that making payments and transferring money is simple. Also, you’ll need a means of keeping track of your expenses and profits – try MS excel.
4. Making Friends with a Contractor: Properties require a lot of upkeep. You may also want to improve your properties to increase the rent. Both of these mean you’ll need someone to help with jobs like roof repair, renovations, remodeling, etc. My advice would be work your personal networks to locate a good small contractor. If you get into real estate, you’ll need one.
*As always, acknowledgments should to go Jane Bryant Quinn for the inspiration for this post.