Thinking about investing in a rental property? What a great thought you have there. However, unlike your first home, purchasing investment homes requires more than just your interests but also all of your real estate knowledge and a business mind. Additionally, being a landlord requires lots of hard work and time devoted to planning and maintaining stable cash flow.
In this blog, I will go over the guidelines to strategically acquire a rental property along with going over the pros and cons in holding a Rental Real Estate portfolio.
Our team here at Chad Vo Real Estate has more than 30 years of combined experiences in Financing, Property Management, Construction, and Real Estate Investing at both small and institutional level so we will be the right team to assist you. Either you are a beginner or an experienced investor, if you have any question or interested to see other perspectives, feel free to reach out to our team at info@chadvorealestate.com to schedule an appointment with us.
Key Takeaways
- Being a landlord requires a broader set of skills from understanding the local rental laws to fixing a leak toilet at 2:00 AM in the morning.
- Passive income isn’t really passive especially when it comes down to real estate investment.
- Besides choosing the right property, investors must be savvy with financing and operations in order to stay profitable in a competitive market.
INVESTORS BEWARE!
Before we start diving into the topics, I want to be real with all the readers first. Yes, rental properties are considered one of the best investments out there and it’s been proven as a solid way to build wealth. However, if you want to invest into rental properties because it sounds easy, convenient, and “passive”, I hate to break it to you but it really is not. At least not as simple as it sounds!
I was never a believer of the concept of “passive income” and I can spend all days debating about this topic. Yes, if set up correctly, there will be very minimal works involved in generating rental income but in order to maintain positive cash flows, you will need a long-term business plan along with ongoing maintenance upkeeps of your rental properties.
The opposing views may argue that a local property managers can take care of the entire process so the stress can be alleviated. Though I do agree, it only helps so much to a certain extent. What if the property managers you hired do not perform up to your standards? What if your monthly cash flow goes negative because the tenants they screen are late on paying you rent?
In my personal opinion, great investors delegate their day-to-day responsibilities to either their own employees or local property managers. However, they, at the end of the day, are the CEO of their own rental portfolios. They make both easy and difficult decisions by analyzing the risks and rewards to make sure there’s a great balance between profitability and their tenants’ happiness. They make sure they know their monthly and year-end financial statements in and out (from expenses to depreciation) along with every single update on their operating areas’ rental laws and regulations.
This is the reality and real responsibilities of savvy investors. I’m a huge advocate of investing in real estate but I just want to make sure before anyone out there plans to use this route to generate passive and stress-free income, this will not be an option for you. For more questions, you can contact me at chad@chadvorealestate.com.
Enough with the negativity, now let’s get to the fun part!
Buy your first rental property with these simple guidelines and become a landlord
At this point, I assume you read my previous paragraph and assume the risks along with the responsibilities of a landlord. Below are the simple guidelines on how you can plan and execute your first rental property acquisition.
1. Plan your personal and business financing
The financing logistics of an investment or rental property is different from obtaining a mortgage for a primary residence as it requires more funds, stricter income qualifications, and more nuances varying by properties. Below are a few common requirements of an investment loan from Fannie Mae:
- A highly recommended credit score of 720 and minimum score of 680 (with other qualifying terms).
- 25% down-payment of the purchase price.
- Applicants will be required to submit the most recent 2 years of tax returns, 2 months worth of bank statements, and proof of income to achieve 43% Debt-to-Income ratio. Just like the primary mortgage, the DTI ratio may vary by lenders.
- Important: most lenders will require a sizable reserved funds that are enough to cover at least 6 months worth of the subject property’s mortgage payment. This is to ensure investors will have enough savings to cover the mortgage in case the tenants default on the rent.
These bullet points can be quite intimidating. However, with some strategic planning sessions, it is quite doable because there are lots of financing options out there for investors. To learn more about these options, email our mortgage department at mortgage@chadvorealestate.com.
2. Master the art of calculating the return on investment (ROI)
Just like any forms of investments, all investors want some sorts of financial returns for their investments. This topic can be quite complex depending on the types of properties and expenses associating with them. Here’s a few basic and common terms every investor should know by heart:
- Annual income: this mainly comes from tenant’s monthly rent payment or the occupancy charges if operating a short-term rental property
- Annual operating expenses: any item that associates with operating the rental properties such as taxes, insurance, property management fees, repairs and upgrades, etc.
- Annual Cash Flow: this can be calculated by the difference between total income and all operating expenses items
- Return on Investment (ROI): this can be calculated by dividing the annual cash flow by the total cash invested (down-payment, closing costs, repairs cost if any, etc.).
For a quick example, assuming that the total funds upfront is $42,000, annual income is $30,000, and annual operating expenses is $24,000 ($20,000 of mortgage payments and $4,000 of miscellaneous expenses). Using the formula provided above, the annual cash flow would be $6,000 ($30,000 – $24,000) and the ROI would be 7% ($6,000 before-tax / $42,000).
We have a simple property analysis and underwriting model available for free that all readers can use to analyze their subject properties. Fill out the form here and we will send it to you via email.
3. Hunt for the right rental property
You can ask many experienced investors and they will agree that not all properties will yield great ROI. As a matter of fact, investing into the wrong deals may pose as greater liabilities than assets. Therefore, before pursuing a deal, all investors must make sure they truly understand how this property will generate profit in both long and short term and how both external and internal factors will affect the cash flow.
Below are a few highly recommended data points all investors should do thorough research when examining a potential investment. These data points can either be purchased through data providers or through web browsing on real estate related sites, census, etc.
- Home values trend to forecast home appreciation
- Average rent prices and vacancy/occupancy rates
- Neighborhood rating and population growth rate
- Job & employment rate and top employers to estimate the average income of the areas
- Property tax rates and frequency of increase (this may affect the potential ROI by increasing expenses)
Lots of these data points if compiled and analyzed correctly, you will make a much more informative decision to either invest or pass on a property. Of course, these data sets can be very overwhelming to look for and tiring to analyze. Investors can also choose to work with a real estate professional to gather these data and perform the analysis. However, it is highly recommended for all investors to perform these exercises at least 3 times to truly understand the concept and to avoid misinformation coming from bad realtors.
Our team not only consists of all real estate professionals but also investors ourselves. We’ve helped countless of investors from shopping for their first homes to their out-of-state rental properties. For any question and comments in investing advices, feel free to reach out at chad@chadvorealestate.com.
4. Keep track of all income and expenses
I cannot stretch this enough. It is so important for all investors to know the in and out of their financial statements. Sometimes, keeping track of these items can easily be extremely tedious and overwhelming. However, just like your own personal bank accounts, you will want to know how your rental business is doing because it’ll indicate if your cashflow levels in both long and short run are in good shape or not.
Don’t know where to start? Here’s a few common items:
- Monthly rental income and other sources (short-term rental, pet fee, storage, laundry machines, etc.)
- Security deposit
- Property management / Leasing fees
- Mortgage payments (Principal and Interest)
- Insurance & Property Taxes
- HOA fees (if any)
- Repairs and maintenance
- Landscaping
- Pest control
- Utilities (common if operating multi-family properties)
- Depreciation expense
- Optional: Owner’s Operating Expenses (gas, car payments, flight tickets, etc.)
Lots of these items can be easily kept track of by using spreadsheet, accounting software, or even traditional notebook. However, as the portfolio grows, I highly recommend investors to reinvest into a Property Management platform, which will help save time and make the process a lot more seamless. Some platforms, with a little more extra fee, will also provide many useful analysis, market datasets, and thoughtful metrics from your portfolio as well.
5. (Optional) Hire a qualified local property manager
At this point, we can all agree that being a landlord can definitely be a lot more time consuming than expected the mentioned responsibilities such as maintenance, repairs, and screening tenants are only parts of many things a landlord usually do day to day.
For the sake of keeping the simplicity of this article, we will not go into details of staying in compliance with the local and state laws when it comes down to property inspections, tenancy laws, and Fair Housing Act along with others but it is absolutely necessary to stay up to date with these requirements because you do not want to add penalty fines and lawyer fees on top of your expenses. Therefore, to some investors who do not have all the time, hiring a qualified property manager will be a great investment that helps save money in the long run.
Just because investors hire property managers, it doesn’t mean they would completely stay out of the operations. The recommended flow and dynamic would be allowing the property managers handle the day-to-day responsibilities so the investors can really focus on searching, analyze, and growing the rental portfolio.
Like I mentioned, just like any other professions out there, there are good and bad property managers. Before onboarding one, make sure as a responsible landlord, you must interview and hire the best property managers that fit your situation. Here’s a few topics of discussion you can go over with the candidates:
- Licenses that are in good standing (or if they have any previous violations)
- Experiences and current/previous experience
- Fee structure
- Their day to day operations and routines
- Reporting and data capabilities
- Optional: How long they’ve been operating in the subject market. I personally believe if you ask the right questions, how long they’ve been in the industry and market may not matter that much. The right candidate will find the best ways to solve any problem. Just because one has been in the industry for a much longer time, it doesn’t mean they’ll perform better than others who are not.
6. MAKE SURE YOU DO YOUR HOMEWORK
Yes, I would like to repeat myself, not all homes would make great investments. As a matter of fact, acquiring wrong rental properties may yield greater liabilities than you would think and same for each operating decisions. Therefore, in order to build a great rental portfolio, make sure that you, as an investor, do your homework thoroughly and understand the process in and out. Great investors truly understand every single metrics associating with a rental property, the dynamic of the markets they plan to invest in, and set realistic goals and expectations for themselves, both short-term and long-term.
By doing your homework and sharpening up your skills, you will build great fortune through your real estate investments. Have more questions or concerns? Feel free to reach out to me at chad@chadvorealestate.com
Want to find out if you’re qualified for a mortgage?
Getting pre-qualified and getting the actual approval from the lender are two completely different things.
Getting pre-qualified or pre-approved by the lender isn’t necessarily guaranteeing that you’ll get the loan but it’s the most common way for them to go over your personal and financial background on the very surface and provide you with a rough estimate of your loan size. As long as all pieces of information you provided to your Loan Officer is as accurate as possible, the final approval should not be an issue.
This step, like I mentioned in my First-time Homebuyer Guidelines article, is indeed the most important step in the purchase journey because it’ll help you build such a strong case for your offering package. And guess what? It’s FREE of charge so make sure you get it done first. If you need help or recommendation, you can reach out to us by sending an email to mortgage@chadvorealestate.com
Have a Topic in mind?
Let us know by filling out the form below or contact us here and we will be more than happy to dive deep in future blogs