{CONTINUED FROM THE BEST INVESTMENT TO MAKE BY AGE 30 – REAL ESTATE}
Last week, I discussed several benefits of investing in rental properties including long-term property appreciation and building a second stream of cash flow.
Today lets’ review an August 2019, purchase of a North Carolina (N.C.) single-family home, rental property. N.C. is both my home and undergraduate college state. I own several investment properties in Raleigh, Durham and Chapel Hill, (Research Triangle Park- RTP) N.C.
For this purchase, I partnered with my daughter, Amanda; to both help start her real estate investment portfolio and learn the investment process. Below outlines the process we used based on lessons learned from the GOOD BAD AND UGLY from my past fourteen real estate investments.
A second objective, as I retired from full time corporate work, is to further increase my monthly cash flows.
STRATEGY FOR BUYING RENTAL PROPERTY
GET COMFORTABLE SAYING NO
“The difference between successful people and really successful people is that really successful people say ‘no’ to almost everything.” Warren Buffett.
We said NO to several potential properties and NO to increasing our offers where the additional dollars did not yield a good return. Finally, we had an opportunity to say yes and purchased a single-family, three bedrooms, two bath home that needs capital improvements.
A capital improvement is the addition of a permanent structural change that will either enhance the property’s overall value, prolongs its useful life, or adapt it to new uses. Anything that increases the value of the property or extends its life is categorized as a “capital expense” and must be capitalized and depreciated over multiple years. Work with your accountant or CPA to make these determinations. Once we compete the rehab this house should appraise for ~$250,000.
IDENTIFY YOUR GOALS:
GOALS:
- Three percent or better annual appreciation, based on historical data of the area. The RTP area is averaging close to six percent.
- Safety
- Good Schools
- Convenient to grocery and other shopping
- Close to major highway entrances
- Properties attractive to Working/Professional Adults and Families
- Six percent or greater annual Return on Investment (ROI)
- Cash Offer – How will you pay for your property? You typically need minimum of 20% down payment for investment property. You will need the credit/collateral for loans. You may be able to use a home equity loan on your own home. Or borrow equity on your existing rental properties.
- 20 year holding period. Decide how long you intend to hold property.
- I will use my current RTP Property Management Firm, which does an outstanding job. Do you have the time and skill sets to manage your properties? Do you want a 3 AM call about stopped up toilets? The alternative is to pay for professional, property management services. Professional services will cost from Five percent to Ten percent of your rent. Remember EVERTHING IS negotiable (if you do not ask, you never know if someone is willing to negotiate}
DO YOUR RESEARCH AND BUY A PROPERTY THAT MEETS OR BETETR EXCEEDS YOUR TARGETS!
Do your real estate market research carefully and only make an offer on properties that meet majority of your requirements. You will pass on properties more often than make an offer. Never fall in love with your properties. A rental property is not your home, but an investment.
After buying a property your job is to continue to manage your properties to achieve targeted ROI. Find the right tenants. Charge market rates; keep your property in the condition that gets you top dollar; replace your property management firm if not satisfied.
“IT’S THE ECONOMY STUPID” – BILL CLINTON {IT’S ALL ABOUT THE NUMBERS}
Before making an offer run the numbers to determine maximum dollarS you can pay. I utilize the below rental property calculator. There are numerous calculators on line or in the app stores.
https://www.calculator.net/rental-property-calculator.html
RECENT PURCHASED PROPERTY COSTS
Asking Price: $200,000
Paid: $185,000
Annual Taxes: $1,800
Annual Insurance: $751
Home-Owners Association = None
Property Management Fee: Seven percent/month
Targeted Rental Revenue: $1,800/month
Holding Period Prior to Potential Sales: 20 Years
RENTAL PROPERTY ASSUMPTIONS
https://www.calculator.net/rental-property-calculator.html
I use the above link to analysis each potential property. You input the above property values and below property assumptions and generate an estimate of Return on Investment.
- Value After Repairs- Based on market analysis of other homes in that area
- Vacancy Rate (eight percent is one month vacant. I attempt to sign tenants to two year contracts to reduce that rate to ~five percent)
- Maintenance Annual Expenses: As we will install new HVAC, new appliances and make other necessary repairs I assume this number will be low in first year or more.
- Other Costs: A miscellaneous cost bucket
- Monthly rent – estimate provided by my Management Firm that has experience renting properties in this area
- Value Appreciation – Use state, county and city average value appreciation. This area is currently running >six percent annual appreciation. I used a more conservative four percent.
- Holding Length- I use 20 years, as I buy properties for long-term cash flow.
- Cost to Sell: Six percent to real estate agent plus miscellaneous closing cost of ~ two percent.
RENTAL PROPERTY CALCULATION ANALYSIS RESULTS
- IRR:The internal rate of return (IRR) is a more exact measurement of a property’s long -term yield
- Cash-on-cash return: Is often used to evaluate the cash flow from income-producing assets.
- Capitalization rate: The rate of return on a real estate investment property … Capitalization Rate = Net Operating Income / Purchase Price.
20-YEAR RETURNS
PROPERTY INSPECTION
After an offer is accepted by the owner, ALWAYS conduct a property inspection, using a qualified inspector. This typically cost $500. An inspection reduces the probability of discovering serious and expensive problems AFTER you are the owner. The inspector will look at exterior and interior conditions including:
- Structural
- Exterior including roof, chimney, gutters and windows and any built structures such as deck, Patton, storage house
- Interior to include: Plumbing; Electrical; Grounding; Condition of Outlets and Ground Fault Interrupters; Lighting, Conditions/Damage to walls, floors, ceiling, cabinets,
- Smoke and CO Detectors Functional or Installed, etc,
- Appliances and HVAC Conditions/Concerns
- Any renovations or structure improvements. Alerting you to possible permitting issues.
- Any safety concerns
Your report will contain detailed list of issues room by room allowing you to estimate cost to make needed repairs and either negotiate with the owner to pay for all or some, or of the necessary repairs.
The property inspection report helps you make an informed decision.
FINAL DECISION – THE PURCHASE
Last week I finalized the purchase of this rental investment property. The property is on ¾ acre, single family, three bedroom, two-bath, single car garage.
EXPECT THE UNEXPECTED
Every form of investing has risk, including buying rental properties. After buying you may discover asbestos that has to be abated, or more serious structural damage, termite damage, etc. A tenant may cause damage to the rental property, not pay rent on time, or vacate the property without notice and take YOUR APPLIANCES with him. At the worse possible time you may be unable to rent a unit for weeks or longer. Regardless of the situation, you need to be prepared, financially, against potential harm to your real estate portfolio.
Having emergency savings for you rental business is as critical as having emergency savings for personal reasons.
PROPERTY MANAGER
For my first rental property I was the property manager. I lived closed to the condo, the unit was under three years in age and I had few problems. Well, except my tenant was late EVERY month paying his rent.
I eventually moved out of the state at about the same time I decided to own multiple rental properties. At this point I hired a Property Manager. A Property Manager can make the difference in losing or making money. Do your research. Meet with 2-3 managers recommended to you or that you find from a Google Search. Walk in with a list of questions. Ask for references. If/when you make a mistake and hire the wrong manager – FIRE THEM and find a new manager. One of my mistakes I kept a bad manager for TOO LONG! Today I have a MUCH better, reliable manager and estimate he is saving me thousands.
CONCLUSION
Real estate investing is the ultimate catalyst for early retirement. It can generate profits, provides tax deductions, and has a long-term advantage of property appreciation. Before starting your real estate investment portfolio, you must plan properly, research and prepare financially.
Now, ask yourself how many rental units you need to buy in order to achieve your income goal? It is probably best to start small with a few property units, and then build towards more, depending on how much rental income you want per month.
“You are wealthy when you non-work passive income equals or exceeds your living expenses.”
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DISCLAIMER
I am a proud nerd (as my beautiful wife and daughter have told me) investment and finance blogger, with a NC State, Chemical Engineering, University Rutgers, MBA and Harvard University, Advanced Management education.
I started my first business at ~13 years of age. am a successful investor in equities and real estate and happy to share my personal finance and investment lessons learned with you. However, I am NOT a licensed financial advisor. Please do not construe my suggestions on this blog, as recommendations for your personal situation. For individual finance advice please seek your own licensed CPA or financial advisors.