With any investment portfolio diversification is key to reducing risk and increasing returns. In addition to stocks and bonds, a rental property can fit well within an investment plan. Below are five tips for helping you get started.
Start as owner-occupant
This is a strategy that my wife and I utilized when we purchased our 4-unit building in Saint Paul. We lived in one unit and rented out the other three which more than covered the mortgage payment. This is essentially eliminates your largest expense in life, your house payment. I am surprised more people don’t do this.
If you don’t want to live that close to your tenants you can also do this with a single family home. With this strategy, you buy a property to live in but plan to rent out later. If you occupy a house for at least a year, you can make a smaller down payment, particularly with HUD or VA-approved properties. After you have lived in the house for at least a year, you find another house to move into, and rent out the original house. Repeat as desired.
The drawback is that you end up moving more frequently which can be a huge pain. It should go without saying but make sure your spouse is on board with this plan before trying it.
Analyze the numbers
Whether you are living in the property or not make sure you analyze the numbers to make sure it cash flows. If you do live in a unit make sure you analyze it as an investment after you leave. Just because your mortgage is paid for while you live there does not mean it will be a good investment once you leave. A good rule of thumb is to assume that 50% of your rents will go towards expenses before you account for your mortgage. So, if you are receiving $2,000 per month in rent assume that $1,000 of that will go towards expenses. This leaves you with $1,000/month to pay the mortgage. Everything after that is cash flow. This doesn’t mean that you will spend that much every month but over time you will need a new roof, siding, furnace, and other expenses. Make sure you are putting some money aside to plan for these expenses.
Find a handyman before something goes wrong
You want to find a trusted handyman before the toilet breaks down or gets clogged. This will avoid the hassle of doing-it-yourself or having to hire someone in a pinch which allows you to shop around for the best price. I have found that Craigslist can be a good source for finding a handyman. Just make sure they are insured and you check their references. Also, know the difference between a handyman and a contractor. If the work requires a permit or involves electrical or plumbing, I would suggest hiring a licensed professional. For drywall, painting, minor appliance repairs, installing flooring, molding, doors, etc., it might make more sense to save the money and go with your trusted handyman.
Find the right real estate agent
Once you’ve done your own research to determine your investment criteria you should consider hiring a real estate professional to help with your property search. They know the market, provide access to the MLS and can help you avoid making dumb mistakes. They may even be able help you with refining your investment criteria. The important thing is to make sure you choose the right one. Ask them if they have experience with investment properties or if they invest in rental properties themselves. You can also arrange for a Realtor to show units once they’re ready to rent.
Resident property manager
You may be able to manage one or two properties by yourself, but if you want help, a property manager will handle everything for you…at a cost. A typical property manager fee is 10% of the monthly rents and one month of rent to place the tenant ad do showings. Property managers usually handle the following tasks:
- Hire the handyman or contractor
- Advertise vacancies
- Show apartments to prospective tenants
- Review rental applications
- Handle the lease signing
- Collect rents
- Process evictions if necessary
If you live in the property it will be much easier to manage the property yourself and will save you a lot of money. If you don’t live in the property it might make more sense to hire a property manager. Remember your time is worth something.
Overall a rental property can be a good complement to your financial portfolio by providing cash flow, diversification, and the potential for appreciation. However, it will require time, effort and can be risky. Investing in real estate is a big decision and it is best to consult with an investment professional, financial planner or Realtor before making any decision.
Phillip Christenson is a fee-only financial planner and blogger at Phillip James Financial in Plymouth, Minnesota and also invests in residential rental properties. You can find more information at http://phillipjamesfinancial.com.