Ask any personal finance expert for advice on becoming financially independent, and the likelihood of you hearing something along the line of, “Consider creating multiple sources of income” is high. Because let’s face it, it’s almost impossible to achieve financial freedom without having a healthy cash flow. And having multiple sources of (passive) income is a sure route – provided you have a healthy spending habit.
Purchasing rental properties both domestically and internationally presents a good way to create a new passive source of income. Yes, there are not many investment opportunities that have made people truly wealthy as real estate. Still, don’t let that trick you to believe that you can starting making a bunch of money overnight. In reality, this can only become a passive income after years of hard work actively – with emphasis on actively – building your real estate business.
Hopefully, you now have the right mindset regarding investing in properties. So let’s try to discuss the what and how building a real estate investment that becomes passive. Obviously, this assumes that you’re looking to do this over a very long timeframe.
What’s the Capital Requirement?
If you have sufficient capital in your savings to finance the purchase of the rental property, it’s a bit easier for you, as it’s easier to do the math of the cost of buying a rental property. However, things would become trickier if you’d be seeking out financing options like getting a mortgage.
BY THE WAY: Lest we forget, it is always advisable to start out with just one property, even if you’re lucky enough to have the capital to get two or more. Here’s why. As with most businesses/investment, you need to understand how it works. The realities of properties are different from one to the other. I mean, the cost of maintenance alone could be discouraging. Take it that the first property is for learning and understanding the tricks behind building a massive passive income stream through rental properties. You don’t want to learn this with multiple properties.
Now back to business. If you would be seeking to take on a mortgage to finance the purchase of your first property, here is a list of costs that you have to bear in mind. We’ll end up coming up with the minimum capital you’d need to buy rental properties in a number of countries.
These costs, in order of occurrence, down payment, closing costs, repair cost and carrying cost.
Breaking it down!
In most countries, 20% of the purchase price is the conventional minimum down payment required to get a mortgage. I particularly researched information for United States, United Kingdom, Canada and Australia and gathered that 20% down payment is the standard.
You want to note though that in some of these countries you might have to get a mortgage insurance. For instance, Australia requires a mortgage insurance when the loan is above 80% of the cost of the property. This could essentially add roughly 1% to your regular interest rate. In the US and Canada, such insurance becomes mandatory only for down payments below 20%.
Since we’re talking about a first property, I suggest for properties in the $100,000 region. Real estate professional like Mark Ferguson of InvestFourMore have found success buying properties in the region of $100,000.
Going by that, you’d be looking to have a down payment of $20,000 ready. Obviously, on an international level, the quality of a $100,000 property would vary.
Please note that this is just a guide for how much a rental property could cost. In essence, whenever you’re ready to take a plunge into the industry, it’s a proper habit to get in touch with a reputable realtor to help you get the best possible property for you money.
It’s inevitable that you’ll have to settling bills while closing the purchase of the property. This cost includes items like attorney fees, recording cost, brokerage commission, appraisal fee, inspection fee, origination fees etc.
Experts advice that you have between two to five percent of the purchase price prepared for the expenses due to closing of the purchase.
By implication, for a $100,000 property, we’re talking about closing cost between $2000 and $5000. But to maintain sanity, let’s go for the mean cost, which would work out to be $3500, or three and half percent of purchase price.
However, depending on whom you’re dealing with, it is possible to have the seller bear some of these expenses. So you should definitely try to see if your seller would bear the cost.
In any case, though, we’ll still have the closing cost in our calculation here.
Repair and Carrying Cost
Chances are that there would always be a number of things to fix before renting it out. While the repairs are taking place, you’d have started settling certain bills like insurance, utility, taxes and interest. And since we don’t live in an ideal world, repairs usually take more time than they should.
In general, a house with minimal repair needs would still require in the region of $5000. Cost could run into $20,000 for a property that requires significant renovation. But with this being the first property, you want to make sure that the repair cost doesn’t exceed 10% of the purchase cost.
And it’s always a helpful habit to get quotations for the repairs in order to get the best deal.
And you should budget about 2% as carrying cost in the process of getting the property ready for rental.
Bringing it All Together
From the estimates above, here is the minimum amount you should have in order to start investing in rental properties.
|Cost Type||Amount ($)|
How Much Mortgage Can You Get?
The truth is that the amount you would be qualify for would depend on your income and your credit score. However, Zillow’s mortgage affordability calculator suggests that you should be able to get up to $100,000 mortgage with a $30,000 annual income and 10% monthly expenses.
What Yield Can You Expect?
The reality is that the yield you’ll get on your property will vary for many reasons. For instance, the state of the local economy and the total annual cost of maintenance will have a part to play. This, I believe, further highlights the usefulness of consulting a professional realtor.
But here’s something for you to get a general sense of what you can expect. According to Global Property Guide, gross rental yield in the US is 3.91%, while it is 4.43% in Canada. It also says gross rental yields for Australia, New Zealand and UK are 4.39, 6.09% and 3.21%, respectively.
Please note that these estimates for before-tax estimates.
Obviously, it’s enticing to consider putting your money countries like Australia, New Zealand and Canada, where the yields are much higher.
If you’re a good risk taker looking at the international option, it’s paramount that you conduct your due diligence as to the legislation and taxes that apply in these countries. Obviously, to invest internationally, which could be very lucrative, you just have to work with a realtor who is local to the place. The internet is a good place to find realtors with good reputation.
One other thing I would have you aware of is the cost of fund transfer when going international. You want to be sure that getting the best deal in every situation. For transfers, it could help to use commercial FX consulting services to find out about the cheaper options for foreign currency transfers that available to you.
On a final note, the importance of dealing with a reputable real estate professional when going into this business cannot be overemphasized. History has shown that those who think they’re cutting costs by not working with realtors end up spending more than they should due to the lack of experience – even Donald Trump advices that you shouldn’t try it.
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him here and here.
He regularly writes about investing, student loan debt, and general personal finance topics geared towards anyone wanting to earn more, get out of debt, and start building wealth for the future.
He has been quoted in major publications including the New York Times, Washington Post, Fox, ABC, NBC, and more. He is also a regular contributor to Forbes.