Why Rental Properties are a Great Way to Diversify Your Investments

Most financial advisers, television shows about money, and even colleges teach people to invest money in the stock market. Real estate is rarely mentioned as a vehicle to invest your money, except when buying a personal residence rather than renting one. I feel investing in real estate with rental properties is one of the best ways to invest your money as well as one of the best ways to retire early. I am biased towards real estate since I am in the real estate industry; I run a real estate team of 10, have 11 long-term rental properties and I fix and flip 10-15 homes a year. But, I have done a lot of research on the best retirement and wealth building vehicles; to me real estate blows the other options out of the water. Why don’t more people invest in real estate if it so great? It takes a lot of education and local market knowledge to be a successful real estate agent, it is not easy to invest in real estate.

When you invest in rental properties, you have to invest for cash flow and not appreciation

One of the biggest mistakes investors make when buying rental properties, is they buy a house and hope for it to appreciate. If you buy a house for cash, you probably won’t get into trouble buying real estate for appreciation, but most of us do not have cash to buy a rental. If you invest for cash flow you do not need a rental property to appreciate to get great returns. Cash flow is the amount of money you make on a rental property every month after paying all expenses. If you buy the right property for the right price and are not in an area with outrageous home prices, you should be able to find a rental property that cash flows.

I am a professional in the real estate industry and my returns may be higher than most. I own 11 long-term rentals and they provide over $60,000 a year in cash flow after all expenses. I bought my first rental property in December of 2010 and I want to buy 100 rental properties by January 2023. The great part about the $60,000 I make every year is it will last as long as I own my rental properties, in fact it will increase over time as I pay off mortgages and inflation causes rents to increase. With the stock market we have to worry about how long we will live in retirement so our money does not run out. With rental properties you never have to worry about your money running out, unless you sell the properties.

How do you figure cash flow on rental properties?

Many investors forget to figure all the costs that are associated with a rental property. There are many more costs than just the mortgage payments. Here is a break down of the most common costs:

• Mortgage payments: If you have a loan you will have mortgage payments, this is an easy one!
• Taxes and insurance: Taxes on real estate varies greatly in different states and towns. I pay about .05% of the value of a home in Colorado, but other areas can pay 10 times more than that. Every home should have insurance on it to protect from fire, flood, etc. If you have a loan on the home, there is a good chance the insurance and taxes will be included in the mortgage payment in the form of an escrow payment.
• HOA dues: If you buy a condo or home in an HOA you will have to pay dues and account for those.
• Maintenance: Maintenance is something many investors under estimate or do not estimate at all. Even if you buy a house that is completely remodeled it will need maintenance. Tenants are not always easy on homes and things break. The older a home is the more maintenance that will be required. I tend to assume 10 to 25 percent of my rents will go towards maintenance depending on the age and condition of my rentals.
• Vacancy: Many investors also forget to account for vacancies, which are times your rental property is not rented and bringing in no income. You may get lucky and have tenants that live in a property for 5 years and always pay rent on time. Don’t count on it! I account for 10% of my rents to go towards vacancies.
• Management: If you do not want to manage your rental properties you can hire a property manager. Typical costs for a property manager can range from 8 to 12 percent of the collected rents and some companies charge leasing fees as well. Every time they lease a property they will charge the owner 1/2 to a full months rent.
• Utilities: If the landlord has to pay utilities these need to be calculated as well. On my single family rentals the tenants pay all the utilities.

Figuring all of these costs is not easy, but I created a cash flow calculator on my blog that makes it much easier. This calculator will help you determine maintenance costs based on the age and condition of a home and its free! Below are the costs associated with one of my rental properties and calculated cash flow.

Rent per month: $1,500
Mortgage payment including interest and principle pay down: -$421
Taxes: -$75
Insurance: -$55
Maintenance: -$225
Vacancies: -$150
HOA: -$0
Utilities: -$0

Cash Flow: $574

If you buy a rental property that has negative cash flow, it does not usually end well. It gets really old paying money into a house every month that is supposed to be an investment. If you ever need to sell the house it will be difficult because it has negative cash flow. Most investors don’t want negative cash flow and if the home is rented it will be hard to sell to an owner occupied buyer.

How much money do you need to buy rental properties

The biggest barrier to entry in the rental property business is the money required to by rental properties and finding good rental properties. If were easy to make 10, 15 or even 20 percent on the cash flow alone with rentals, everyone would do it. When you buy a rental property with a loan, almost every bank will require at least 20% down. You may also have to pay closing costs, which run about 3% of the purchase price of the property, although you can ask the seller to pay them reducing your cash into the property. If a home needs repairs you will have to pay for those as well before it can be rented. The properties I buy cost between $80,000 and $130,000 and I usually put between $25,000 and $30,000 cash into them.

If you don’t have that much money or live in an area with higher prices that require even more cash, there are ways to buy with less cash. The easiest way to buy a rental property with less cash down is to buy as an owner occupant. When you buy as an owner occupant you have to live in the home for at least one year and then you can rent out the property. Owner occupants can buy a house with no money down using a USDA rural development loan or a VA loan. Using FHA or conventional financing owner occupants can buy a home with as little as 3.5% down.

Buying rental properties below market value

One of the huge advantages real estate has over most investments is you can buy properties below market value. With stocks, you can buy companies that you think are undervalued by the market, but you can’t buy them below market value. You can buy real estate below market value for a number of reasons.

• A house is a foreclosure or short sale and the bank wants to sell it fast
• A home needs a lot of work and anyone who buys it will want a steep discount for the work and risk involved and the home may not qualify for financing
• The seller is not knowledgeable about market prices and lists their home below market value (homes are much more difficult to value than stocks)
• An estate is selling a home and they want to get rid of it as fast as possible
• A home is being sold at auction with limited exposure and only to cash buyers

I buy all of my rental properties and fix and flips well below market value. I want my rental properties at least 20% below market value and in certain areas that have a high rent to value ratio. My typical house rents for $1,200 to $1,500 and as I mentioned costs from $80,000 to $130,000 with the lower priced houses needing more repairs than the more expensive ones. When I buy a house 20% below market value I make almost my entire cash investment back as soon as I sign the closing documents. I also increase my cash flow by buying below market value, but it does take more cash when I have to repair a home.

How hard is it to find great rental properties?

Investing in rental properties sounds awesome right? Now you have gotten to the hard part, finding properties that will cash flow and can be bought below market value. I am lucky that I am in an area in Northern Colorado that has great rent/value ratios and decently priced homes. Some of you reading may be in areas where the cost to buy a house is four times as high and the rents don’t come close to cash flowing. The first step in investing in rental properties is identifying the best locations to buy. In some cases you may have to research other neighborhoods or towns that make sense to invest in. One of the hardest parts of buying rental properties is finding the right location. The first step is to ask anyone you know who is in the industry where a good place to buy rentals may be. Then check out the area using the cash flow calculator to determine if you can make money there. Who do you ask?

• Real estate agents: you will need a great agent at some point and you can never start looking too soon. Sometimes the best agents are young and inexperienced but willing to work hard to get deals done.
• Title companies: they see investment properties being bought and sold all the time.
• Lenders: they know where the investors they are working with are buying homes.
• Property managers: you may need a property manager at some point as well, but they will know where good rent to value ratio areas are.
• Investors: if you know any investors don’t be afraid to ask them. If you don’t know any, look up local REIA meetups in your area and start attending the meetings.

Once you have identified a great area for rental properties, you have to find the properties. First you better talk to a lender to make sure you can qualify for a loan and buy one in the first place! When looking for rental properties you will need a real estate agent who is willing to work hard for you. That means they will show you houses very quickly and write offers very quickly as well as find you deals. Most experienced agents may not have time to give you the attention you need. That is why I suggested using a young agent who is full of ambition and has plenty of time on their hands. That agent should also be able to point to you a lender to get qualified with. When looking to buy rental properties below market value look for auction properties, estate properties, REOs, short sales and traditional sales. In today’s market it is important to act fast! That is why you need an agent who can show houses right away and who can write offers right away.

If you have looked and looked and cannot find anywhere close with cash flowing properties, there is the option of long-distance investing. Long-distance investing involves buying property out of state and then relying on a property manager to maintain and rent the property for you. There are also turn-key companies that buy, fix up houses, rent them, place a property manager in place and then sell the house rented. The great part about turn-key properties is they are rented in a cash flow positive area, but you aren’t going to be buying them below market value since the seller wants a premium for these properties.

How can a college students get started investing in rental properties?

Most college students do not have the cash or income to buy a house, but there are a few options to consider. One of those options is the kiddie condo loan, which allows a college student or young adult to buy a house with a blood relative as a co-signor. Both the young adult and the co-signor are on the Deed and one must live in the house. The down payment may be as low as 3.5% and rooms can be rented out to other people as long as local zoning laws allow it. The young adult or student does not need income to qualify for the loan as the co-signor can use their income.

The best part about a kiddie condo loan is if other rooms are rented out the student may be able to use the rent to pay the mortgage and have some left over as well. Not only is the student living rent free, but they are making money as well! If the student can qualify for an owner occupant loan without a co-signor they could buy a home on their own using this strategy as well. If the home is a good rental property the rent from the other students should pay for the mortgage plus some. Once the student moves out, they can rent the entire property and make even more money.

How risky is buying rental properties?

I can imagine many of you are probably thinking this all sounds great until the real estate market falls apart and home prices crash again. That is a valid concern with any investment, but if you buy a home with great cash flow rental properties are no as risky as you may think. During the last housing crash we saw prices drop 50% or more in some areas and many people were hurt badly by the crash. Rents also dropped in some areas, but not as much as prices dropped. It is important to realize rents are not directly tied to house values. House values are based on the supply and demand of houses for sale, but rents are based on the supply and demand of rentals available. In the last crash our rents went down maybe 10% in some areas and some areas saw no decrease. People will always need a place to live and if you buy with plenty of cash flow, then small rent decreases should not hurt you. The huge decreases in home values will not affect you unless you have to sell. Our values have g0ne up past where they were before the housing crisis.

About Mark Ferguson

Mark has been a licensed real estate agent since 2001 and specializes in REO and HUD listings. He currently runs a team of ten, which includes 6 licensed agents. Mark own 11 long-term rental properties and fix and flips 10-15 homes a year. Mark also runs InvestFourMore.com, a blog dedicated to discussing his rental properties, fix and flips and becoming a real estate agent.