Part 2 of 4 of the series on Residential Real Estate Investment Basics: Getting Started in Rental Property Investing
Beginning residential real estate rental property investment typically involves acquiring a single-family home, or a multi-family property, specifically, a duplex, triplex, or quad. The most basic investment plan will calculate the costs to ensure that the rental price will cover the monthly expenses, including predetermined vacancy, maintenance, management, and capital expenditure estimates. In my opinion purchasing a property that does not provide cash flow above and beyond these costs, should not be pursued. The idea that the property appreciation alone is a sufficient factor for purchasing the investment property has led many investors to failure. That being said, moving past this simple theory, you have multiple roads to choose from.

For the beginner, the most basic strategy is to “buy and hold,” which simply involves purchasing a property, simple renovations (such as paint and carpet), finding tenants, maintaining the property, and minimizing vacancy. There are two types of returns that we are interested in here: 1) monthly cash flow from rental income; and 2) gains from eventual sale of the property. This is as simple as it gets. You buy a property for a price that allows you to receive a monthly rental amount that is X amount over your monthly carrying costs. Then, at some time down the road, you sell for an amount Y, which should be higher than the price you paid for the property.  The big question is what target amount for X should you aim for? The answer to this depends on numerous factors, including location, and type of investment. However, to simplify, for your first property, calculate a monthly cash flow of at least $100 per door after conservative expense estimates.

There are of course numerous factors and strategies that you can apply to manipulate this basic strategy for maximum gains, and most importantly, for your specific situation. These factors include: 1) method of purchase; 2) predetermined holding period; 3) renovation strategy; 4) refinance strategy; and 5) trade-up strategy.

There are many more avenues to purchase a property than you likely realized. Here is a breakdown of strategies and a quick pros/cons comparison:

Method

Summary

Pros

Cons

Cash

·      All cash sale

 

·      Quick transaction

·      No mortgage fees

·      Attractive to sellers

·      Must have liquid funds

·      Minimizes ability to invest in other properties

Conventional Mortgage

·      At least 20% cash down. Loan for remaining amount

·      Need only 20% of total price.

·      Can amortize balance over a long period (typically 30 years)

·      Loan fees

·      Interest paid to lender

Seller Financing

·      Land contract

·      Alternative for those who cannot qualify for conventional lending

·      Can be easier transaction

Higher interest rate than conventional mortgage.

·      Typically includes a balloon payment

Hard Money

·      Loans from private investors

·      Quick process

·      Alternative for those who cannot qualify for conventional lending

·      Short-term financing

·      High interest rates

 
The second factor is the holding period. I titled this “predetermined holding period” because you should have an exit strategy prepared for each property when making an offer to buy that property in the first place.  There is not a single standard duration of ownership for everyone/every property. Many purchase an investment property with a conventional loan, maintain it, keep it occupied with tenants, and cash flow for years until the property is loan free. Others, purchase a property, renovate, find tenants, and sell the property within a year for a quick gain. There are many strategies in between, but these two strategies provide good bookends to use when planning for your own pursuits. The first is about creating long-term wealth. The second is about short-term profits.

The third factor is the renovation strategy. Some rental properties can be purchased in great shape and are either already tenant-occupied, or are move in ready (or close to it). These properties are usually priced higher, but involve less work. Other properties need moderate to massive renovations, but are usually priced at a discount related to scope of worked needed. Typically, an investor who wants to turn this property quicker will purchase a property that is priced low, but can be renovated and completed for a total cost well under fair market value. This allows the investor to use the short-term holding strategy discussed in the previous paragraph.

The fourth factor is often overlooked. There are two main refinance strategies: 1) refinance a higher interest rate to a lower rate; and 2) refinance to provide purchasing power towards other investment properties. The first strategy is usually employed when you do not obtain a conventional loan to purchase. Thus, you have a hard money loan or seller financing. Once you can obtain the conventional loan, you do this to lower your monthly payment. The second strategy involves refinancing a property you purchased in a cash sale, or refinancing a property that has equity. You can tap the equity in these properties to use the cash to purchase additional investments. The most common and in my opinion smartest refinance strategy is called BRRRR. This is BUY, REHAB, RENT, REFINANCE, REPEAT. This strategy is literally following those steps exactly. The theory is that you buy undervalued property, you renovate to increase the property value exponentially, you attract renters, then, refinance to approximately 80% of the value of the home, pulling the extra cash out to buy the next property. This is a continual process, which with proper planning and execution allows for wealth creation without a massive initial investment.

Finally, the basic trade-up strategy is to acquire an investment property, sell for a gain, then buy a “better” property. The idea is to move from a single family to 2, 3, or 4 unit multi-family properties. Then, eventually move on to larger apartment buildings. The reason to acquire more “doors” per property is that profit per property should increase with the number of units, and at the same time maintenance costs per unit will decrease. There is a tax-advantaged way to make this trade-up strategy more feasible, which is known as the 1031 exchange. This clause in the tax code allows you to defer taxes on the sale of a property, provided you acquire a new property within a certain time period. This is the simplified version. There is more to it, but that is better discussed with your CPA/Tax attorney. The bottom-line here is that by deferring the taxes, you will have more capital to invest in the next property

As you can see, there are numerous paths to take in residential real estate investing. In my opinion, residential real estate investing is the best way to build wealth. For most, this is a marathon, not a sprint. As with any investment, it should be properly planned and executed. CLICK HERE to contact me and I will work with you to find your next (first) investment property.

This is PART 2 of 4 of Residential Real Estate Investment Basics

Click Here for PART 1: Real Estate Investing Success: Work Harder and Smarter

Check Back for PART 3 of 4: New Development (coming soon)