Every seasoned real estate investor understands that to make money it’s all about how you buy. If you enter into your investment correctly, everything else will fall into place. We all hear stories of the guy who thinks that if the mortgage is less than the rent payment they will make money. That’s not always the case. Here I will give you a checklist that outlines 7 ways you can avoid mistakes before you buy and manage a property.
1. Look For A High Rent-to-Value Ratio
Going in to any property, you want to make sure that your rent-to-value ratio is as high as possible. If you are not familiar with the rent to value ratio, this is just a fancy pants way of saying you need the highest rent possible for the price you paid on the home. Maybe you are saying “Thanks Captain Obvious”, but mapping this out is extremely important. In most areas, you want at least 1% per month, or 12% per year. This means that if you buy a $100,000 property, it needs to be rented for $1,000/month.
2. Keep Your Taxes Low
You should think of your taxes as a mortgage that never goes away. Taxes can vary from one neighborhood to the next. A $100,000 home can have a $3,000 annual tax bill on one street, and a $1,000 tax bill on another. All while having the same rental income! You need to have a good idea of the taxes in the city you plan to invest ahead of time. This way you can track when homes taxes are above or below average. Like T-Pain says, keep those taxes low, low, low, low (That is what he said right?).
3. Put 25% Down (Or 75% Leverage)
Throw some cash at that Investment! Having equity in your investments is beneficial for many reasons. For one, it protects you from market downturns. This will give you a cash flow “buffer” if rents in your area were to ever decrease by a significant percentage. The”buffer” is key for anyone wanting to invest for the long run.
Having equity in your property also increases you cash-on-cash return. This is the return you get on your cash invested, and will give you an idea of the potential cash distributions over the life of an investment. You can find this by dividing the annual income of the property by your down payment.
4 Make Sure You Have Immediate Equity
This is another way of saying buy your property on sale. Warren Buffet said “Whether it’s socks or stocks, I want to buy quality merchandise on sale” (I tried to come up with my own quote but nothing rhymed with property). The same goes for rental properties. Buying a home on sale gives you immediate equity, which means if you need to sell quickly (good or bad), you have the freedom to do so, while reducing your risk. One of my favorite books on real estate investing, The Millionaire Real Estate Investor
5. Keep Maintenance Expenses Low
Those pesky phone calls to change a light bulb will drive someone mad. Luckily, if you plan correctly, they will hardly ever happen. The biggest way to do this is make sure you spend the money up front on your repairs needed. All functional items should be solid and in pristine working condition. This does not mean go buy golden toilets and marble shower tile. It is simply ensuring that the toilets flush, the door open correctly, the HVAC is clean. All these costs up front will reward you by having less maintenance calls, and tenants that stay in your property for a longer period of time. Not to mention, it lowers your expenses in the end.
Some successful investors will get rid of the items in their property that have moving parts. This includes ceiling fans, garbage disposals, washer and dryer, etc. Then add higher quality, desirable cosmetic items. This significantly reduces maintenance calls on the items that break most often. You want to reduce our chance of receiving that 3am call!
6. Screen Your Tenants
Once you have your property ready, it is time to find a tenant. You can’t just put up a sign and let the first person who calls rent the house, you have to screen your tenants. This goes along with the mantra that if you do it right up front, you’ll save yourself a lot of headaches later.
You want to focus on four main criteria when screening tenants:
1. Credit History: Including the content of their credit.
2. Background Check: Make sure you are not renting to Ted Bundy.
3. Income: Make sure they are making stacks (If not, tell them about this really cool site called Dollar After Dollar) or just 3 times the monthly rent. If the rent is $1,000 a month, they need to be making $3,000 a month.
4. Prior Rental History: This will tell you a lot about your potential tenant, including if they have ever been evicted. Make sure you call previous landlords and ask them questions abut the tenant.
7. You Must Actively Manage Your Tenants
Real Estate is not passive, but it doesn’t have to take a lot of your precious time either. Making sure you are paid is the why you do this!
I’m not talking about getting your crazy uncles German Shepard and banging on your tenants front door every month. You just need to remind your tenants who have not paid that they need to get with the program! One cool way you can do this passively, is to set up an automated phone call reminder. If your rent is due on the 1st, and late fees kick in on the 5th, then you can set up automated calls the day before each date. So the last day of every month, each tenant will receive a friendly reminder that is pre-recorded. If the payment doesn’t come in by the 4th, they will receive another call stating the late fee kicks in tomorrow.
Another active management tactic is to schedule a walk through one month after a new tenant moves in. You state that this walk through is for the tenants benefit, and it is, because they will help you address any repairs they need up front. It is also so you can see how the tenant lives. If they trash the place after being in your unit only 30 days, then you may need an action plan to remove that tenant. This can save you in the long run.
Sum this baby up!
We all have different end games, find what works for you and chase after it.
If your new to real estate, make sure you do your research before investing. There are a lot of things to understand before diving in. As the market rises, there is a surge of uneducated investors looking to make money. This can be a dangerous trap to fall into. Take your time and learn the metrics and concepts, then jump in and get your real world education. There will never be a dull moment!
If you want to read more, check out my favorite real estate investing books:
The Millionaire Real Estate Investor
The Book on Managing Rental Properties
Cheers!
Andrew
Andrew is the host of The Personal Finance Podcast, a show that is changing the way you think about your money. His primary goal with the podcast is to bring as much value as possible to his listeners.
Andrew's favorite free financial tool he's been using since 2014 to manage his net worth is Personal Capital. Each month he uses their free Investment Checkup tool and Retirement Planner to track his investments and ensure that he's on the fast track to financial freedom.
His favorite investment platform is M1 Finance, a site that allows him to build a custom portfolio of stocks for free. It has no trading fees and is his preferred way to invest without having to lift a finger.
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