Investing in rental property is one of many ways of building assets to achieve financial independence. I have reflected on my 10 years of experience to write about a structured process you should follow to succeed in this business. I am sharing lessons learned and warning signs. Read on about selection, financing, and management of a rental property. I hope this will be an inspiration to you.
You must follow a structured process to become great at investing in rental property
Investing in rental property starts with selecting the right piece of real estate
This sounds easy. There is a number of elements you need to consider when investing in rental property. Three key things here for starters: location, location, location. Some other things to consider are certain math you need to do. You also need to commit yourself to viewing a certain number of properties before you make an offer. Practice makes perfect.
Location, location, location
First of all, if you choose a good location you will enhance your chances of finding a good tenant (you can read more on tenants later on in this text). Secondly, a good location is also a great way to manage a risk of your property decreasing in value. Finally, great location will also be a good argument when negotiating financing with your bank.
Investing in rental property is numbers game
When you buy a home or flat for yourself and your family you will probably be more guided by emotions. When investing in rental property you absolutely must understand that this is all about numbers. To cut the long story short you need to make sure that every single investment decision will contribute positively to your cash flow. What do I mean by that? You will have certain expenses: mortgage, taxes, maintenance and repairs, and improvement. On the other hand, you will have rent paid by your tenants. If you are spending more than getting on a month by month basis than you have done something wrong.
Viewing more properties increases your success rate in investing in rental property
Finally, let me cast some light on a common mistake. People get so excited to start building their financial independence that they will buy first, the second or the third property they have seen. Don’t do it. Have a look at ten or twenty. Get some experience. Compare various options. Practice your numbers game.
The big day comes. You are about to purchase real estate. Investing in rental property is not a plan anymore it becomes real.
You have followed a rigorous and time-consuming process to select your first rental property. You are now ready to purchase it and start investing in rental property. The key question that you need to answer: what is the best way to finance it to achieve the greatest results?
The power of leverage when investing in rental property
One of the most powerful real estate investing tips is to use leverage. Financial institutions are more than happy to finance rental properties which means that you only need to put up some cash up front to become a landlord. Using leverage helps you achieve more in a shorter period. I have used leverage massively over the last ten years. It allowed me to grow significantly over time. I need to underline one thing here. Fast growth is great but before you decide to expand fast start slow and small. This is how you will learn what assets are all about. You will make mistakes. Everyone does. It is better to make a little mistake and learn a lesson than make a big mistake and be unable to recover from it for many years. Let me show you a couple of lessons learned so that you can avoid some mistakes on your way to financial independence.
Lessons learned on leveraging when investing in rental properties
Follow a golden rule o 20% down payment for your safety and better price
One of the golden rules when investing in rental property is to pay 20% of your project in cash. There are at least two key reasons for that.
First of all, this is for your own safety in case of real estate market prices go down. I know that salespeople like real estate developers and bankers will tell you that real estate prices always go up. We have seen in times and again that it is not necessarily the case.
The second reason is, that financial institutions will be willing to give you a better price for financing if you show that you have some cash to be paid upfront. There is a mechanism in banking called scoring. Based on a number of demographical data, financial data and behavioral data banks calculate how much risk they will take when extending financing to you. The less the risk the better the price.
Follow 20% rule when you are starting investing in rental properties. Buy five or ten units and you will know if you can relax that condition or stick to it on your journey to financial independence.
Make sure you understand your debt to income ratio
Financial independence does not necessarily mean that you are debt free. One of the reasons is that there are different types of debt. Some debt may drag you down other can significantly accelerate your journey to financial independence. Irrespective of the type of debt you carry you need to always understand how much in percent your annual debt payments are in relation to your net income. You will probably not want to see this metric greater than 25% for your safety.
I highly recommend that before you started investing in rental property you make all efforts to eliminate all bad debt that you carry. I am talking car lease payments, credit cards, cash loans, overdrafts and retail debt. The less bad debt you carry the better your debt to income ratio. More importantly, your scoring with financial institutions will rocket and again you will get a better price on your leveraged investment.
Read more about bad debt here Bad debt your number one enemy
Avoid toxic loans and shop around before you sign
Beware of toxic bank products when investing in rental property. Variable rate mortgages on sale are the greatest example. You will see ads, posters, and commercials with rates that are way below what competition charges. Believe me, I have been in banking for 15 years and know that if you get something cheap at the start there is a good chance you will pay for it later. You need to be especially cautious with variable rate financing that might be attractive for a year or two. But then when standard rates kick in you might be unpleasantly surprised. As a rule of thumb stick to fixed-rate financing when you start your journey with investing in rental property.
Do not sign a loan agreement with the first bank that is willing to lend you the money. When you have 20% in cash and you followed my recommendation to cut on bad debt, all banks will want to lend you money. Get at least five offers. Compare interest rates. Compare additional conditions. Do they want to sell you insurance, bank account or any other product? Make sure you understand the total cost before you sign the best contract.
Read more about the power of leverage here: How to borrow money like rich people
You now own it. Investing in rental property does not finish when you buy. It is only the beginning.
Well done! You have selected and bought your first property. So far everything you considered in terms of return on investment was all in your excel file. It is the time to put your calculations and assumptions to the test. The only judge here is the free market. Potential tenants will prove you right or wrong in terms of setting rent. Setting the price is only a tip of an iceberg when it comes to rental property management. Here is a number of steps that you will typically need to make when investing in rental property. You can always consider hiring a professional property manager but that is a different story.
Marketing your rental property
You will need to sell your property to potential customers. The rise of the Internet made it extremely easy to get thousands of clients using popular real estate sites. Make sure you have great pictures, add a video if you can. Attach a floor plan and do not forget to be as much descriptive in the ad as possible. You might want to showcase the benefits of location, transport links, the proximity of entertainment venues or any other thing that might interest your potential customer.
Showing your rental property to potential clients and selecting the best customer
People have started calling you and want to meet and have a look at the property. Make sure you are prepared. Have a copy of most important documents. Know costs that will typically be borne by the tenant. Understand your negotiation margin. Make sure you highlight the importance of taking a cash deposit in case of damage or lack of payments. Be frank with your clients. Also be cautious. Same as you did not start investing in rental property with the first piece of real estate you saw, same you do not want to let it to the first person that shows up at your door. You need to understand if they have a stable source of income. It is always great to get their references from previous places where they rented in order to avoid troublemakers.
Contracting and handing off your property to clients
I used to teach contracting law to students at a university. The key thing I always repeated is that a well-written contract is the greatest tool to manage your risks. When investing in rental property your contract should be written by a lawyer, especially when this is your first rental property. Get a good template once and you will avoid a lot of headache along the way. Make sure that on top of the contract you always, let me repeat, always prepare a hand over report. This is where you need to make a detailed inventory of everything that is a part of your rental property. Listing items is not enough. Make sure you describe their technical conditions and take pictures. You will save yourself a lot of trouble when your tenant moves out and does not want to cover for things they broke or stole.
Collecting rent, paying bills and other admin
You will get to understand that there is always some admin work when investing in rental property. You need to make sure that rent is paid and follow-up if it is not. There will be some payments that you will need to make, like taxes, insurance. You might want to inspect your property every quarter or so to see if there is no damage made and maybe have a short chat with neighbors. Other things might also come up. Be prepared.
Investing in rental property requires preparation
Last but not least you need to understand how money works before you start investing in a rental property. This will require you to work on your financial IQ. The fact is that financial IQ is not something you are typically born with. Your financial intelligence needs to be trained and developed by yourself. Those people I know, who have succeeded in investing in a rental property, share some common characteristics. They all understand their budget – what comes in and what goes out. Debt is used only as leverage by them and they keep away from bad debt. They buy assets that give them cash which is used to buy more assets. More interestingly, they have not been born like that. I saw them develop over time. They have made a lot of mistakes but that have taken their lessons.
There is plenty of materials our there on financial independence. I have been studying those over last 15 years to help me with my journey. You can take benefit of all those years and take my free online financial IQ test. It is never too late to start working on your financial IQ.
Start today. Take the free financial IQ assessment.
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