Our biggest financial goal is to become financially independent: where our passive income covers our expenses and we have the option of continuing to pursue earned income (through traditional employment) or retiring early. Passive income is income generated passively (without you trading your time for money), such as interest earned on your investments, royalties from a book, some types of business income, and rental income to name a few. We want to make sure we have multiple (and diversified) streams of passive income in case one or more streams are affected (i.e. stock market crashes, pension reduces or disappears, real estate market crashes, etc.). One component to help us achieve financial independence will be our rental income (earned through at least three rental properties).
Our first non-investment property
The first house we purchased was not purchased as an investment property (nor was the second one), but we’ve turned both of those houses into rental properties and picked a third one up along the way. Purchasing a home and purchasing an investment property are two completely different transactions. If you own a home (or have even rented) you know it can take time to find the “perfect” place – you look for the perfect neighborhood, a style you like, a mortgage you can afford, etc. When looking for an investment property, your potential rental income is the driving factor which forces you to analyze the property in a completely different way.
We purchased our first home in our mid-thirties because we thought it was our next logical step. My husband is in the military and we eventually had to move, so we decided to convert our home into a rental property. We knew that to make that work we needed the rent to cover at least our mortgage (which also included property tax and insurance), and ideally to cover our property management fees.
I’m not a real estate expert and there are many more intricacies than I can share with you in a single blog post. There are numerous blogs and other resources dedicated to investment properties which will provide you more detailed than I can present to you. But, I can share with you my experience and the investment property path my husband and I chose (or rather, the path that led us to owning investment properties).
Analyzing a rental property
Finding a single rental property can take hours, days, and even months of research (and you should do research). You have to consider the type of property (single family, multi-family, commercial), city and neighborhood, potential rental income vs. the cost to own the property (mortgage, property tax, insurance, vacancy rates, maintenance, repair, property management and more). Analyzing an investment property is (usually) completely different than purchasing a home. In general, you want to make sure you meet the one percent rule which means that the rent you can charge/collect for a property should be at least one percent of the purchase price (plus any repairs required to make the property ready to rent). For example, if you’re looking at a property that costs $100,000 and it will take about $20,000 to repair, your total cost is $120,000. One percent of 120,000 (120,000 x .01) = $1200. Therefore, you should be able to collect $1200 a month in rent to meet the one percent rule. This is what many investors use to narrow down the field and then they will analyze these properties further to determine if it is a good investment for them. Depending on where you live, it may or may not be possible to find a property that meets the one percent rule. And, I can tell you from experience from purchasing our third home (officially purchased as an investment property – I’ll cover that in a different post) it takes effort and time to find properties, make estimates and crunch the numbers.
I’m fairly certain many people who want to own rental properties shy away because it seems overwhelming or they suffer from analysis paralysis and never make their first purchase. Therefore, I offer you a different approach: consider converting your home into a rental property to get your feet wet and help you learn how to evaluate and manage an investment property.
Converting your home to a rental home
If you own a home, consider converting it to a rental property. You’ll need to research rents and property management (unless you plan to manage the property yourself) to see if it’s feasible to cover your monthly mortgage and property management fee (usually between 8-10% of your monthly rent) with local rents (or come close). This may be an easier and more feasible step for you to take if you’re looking to get into the rental property game. Don’t know how much rent is in the area or how much rent your property could fetch? Look at comparable rentals on Zillow.com, drive around your area and look for “For Rent” signs, search on Craigslist.
Our house is in a fairly desirable neighborhood (one where we would likely not be able to find an investment property that meets the 1% rule, and wouldn’t even consider the area to purchase strictly an investment property unless there was another housing crisis). There are few properties for rent, so there is always a demand. We lived in our house for several years and have made many improvements. It doesn’t meet the 1% rule – it meets the half percent rule (that’s not a rule, but the reality we faced). However, we had paid little more than 20% down when we purchased the property and were able to refinance to almost a 3% mortgage rate, so the rent in the area just covers the mortgage and property management fee.
Taking the non-investment property plunge
We found a property manager and listed our property for rent about two months before we were planning to move out. It was rented before we left with a lease start date the day after we vacated. Even if we didn’t need to move, we could have always listed our house for rent on Zillow to gauge interest. If the numbers worked out we could have made this move on our own (by renting another property). Why rent out your home if you’re not making any money?? Good question! To test your real estate investor chops and for the experience! You will quickly learn if you can afford this option (you’ll find that since you’re not making any money, you’ll be out of pocket for any vacant months and maintenance and repair costs, which are inevitable). Even if this were a true investment property (that met the 1% rule) you’d likely only be making a few hundred dollars a month which likely also won’t always cover all of your costs. If you are able to make ends meet and feel like you are interested in another rental property, you can take what you learn, do additional research and purchase a true investment property. At the end of the day, you have someone helping you build equity.
If you’re a true real estate investor, you’ll want and own properties that make you money…that’s your goal. But, do what you need to do to take the first step. Don’t be afraid to try something risky and converting your home into a rental mitigates some of the risk. After the lease is up, you can move back in if you decide this isn’t for you, or if the property is never rented, you can take it off the market and regroup.
The future of our first non-investment property
We’ve rented our first non-investment property for almost four years, had two sets of tenants and it’s only been vacant for about two months. We’ve had regular maintenance costs and some repairs, but we’ve not been out of pocket too much (less than $2000). We’re not sure how long we’ll keep it as an investment property as we expect major repairs to come up in the near future and will need to decide if it’s worth the money to fix it or if we’d be better off selling it. But, it’s working for us at the moment.
Do you have any rental properties or have you considered purchasing one?
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