Today’s post comes from my good blogging friend Andrew, who blogs over at Living Rich Cheaply. There he talks about building wealth while living in one of the most expensive cities in the U.S., NYC. Today he is sharing his experience in real estate investing. Enjoy!
There is an allure to making it rich investing in real estate. There are late night infomercials telling you they can teach you to build a real estate empire. There are shows about making big bucks flipping houses. Real estate investing is NOT a get rich quick scheme, but it is a great way to build wealth. If done right, investing in real estate has many benefits including having monthly cash flow, tax benefits, having your tenants’ rent check pay the mortgage, leverage and appreciation. There are many ways to invest in real estate but for purposes of this post, I am going to focus on buy and hold real estate investing.
Are you sure you want to invest in real estate?
Unlike investing in an index fund, you can’t just open an account and forget about it. Investing in real estate involves more of your time and effort. If you like the idea of investing in real estate but want a much more passive investment, consider investing in a Real Estate Investment Trust (REIT) or a crowdfunded real estate platform.
Recommended Reading: Building Wealth One House at a Time, Updated and Expanded, Second Edition (Real Estate)
Are you Financially Ready?
Whereas you can open a stock brokerage account for as little as a few hundred dollars, you can’t really do that if you want to invest in rental property. You need to save up for the down payment and for closing costs. Also, since you will likely need to obtain financing to invest in real estate, you will want to have good credit so that you can get the best rates. So get your finances in order, save up some money and improve your credit score before getting started. You will also want to learn as much as you can about real estate investing before you jump in so that you have a better chance in avoiding common pitfalls. I did extensive research before I bought my first rental property. Read books about investing in real estate, check out the BiggerPockets website, and go to a local real estate investor association (REIA) events and talk to other real estate investors.
Recommended Reading: The Book on Rental Property Investing: How to Create Wealth and Passive Income Through Intelligent Buy & Hold Real Estate Investing!
Okay, I’m ready! Now what?
Location Location Location
“The biggest financial risk when investing in real estate isn’t the condition of the property, but its location. You can change everything else.” – Dr. Andrew Schiller
Most people will invest in the area near where they live. You’ll likely know and understand the market conditions and the neighborhoods better. And if you will be self-managing the properties, it’s best to be close in proximity. I would have preferred to invest close to where I live, but I live in NYC and real estate is too expensive so I decided to purchase a rental property out of state. Depending on what your goals are (cash flow, appreciation, etc), will depend on what type of neighborhood you want to invest in. However, the most important factor is to make sure there is demand for rental housing in the neighborhood you choose make your purchase. Things you should consider are the proximity of good paying jobs, crime in the area, and the quality of the schools.
General Rules of Thumb
The 1% Rule
Generally, you will want the monthly rent of the property to be 1% of the cost of the property. For example, if you are thinking about purchasing a property for $100,000, it should rent for at least $1000. If you are thinking about purchasing a property for $200,000, it should rent for at least $2000. To find out what the property will likely rent for, you can check out sites like Zillow, which will give you a pretty good estimate.
The 50% rule
Generally, the expenses (not including the mortgage expense) on the rental will be 50 percent of the rent. The expenses include maintenance, insurance, taxes, and vacancies.
Of course, these are just general rules of thumb. When you are ready to buy the property, make sure to run the numbers to determine if the investment makes sense. This is just a quick and easy way to screen out properties where the math does not make sense for an investment property.
When I tell people about my rental property, they ask how much the mortgage payments are and how the property rents for. They assume the difference is what I pocket every month. I wish! The monthly rental income I receive is $850 and the mortgage payment including taxes and insurance is about $485. I also pay $77 for a property manager. You also have to take into account money that you’ll eventually spend on repairs and vacancies.
Other things that you should consider is to work with realtor who deals with investors. Working with people who plan on buying their dream home and working with people who want to make money on the property are two different things. You should also have a look at the property through the eyes of a tenant and not as a house you will be living in. Also, make sure you get a thorough inspection of the property.
Potential Pitfalls
So earlier I mentioned that you have to have money for down payment and closing costs, but that is not all. You can’t expect to buy the property and immediately rent it out, you have to allot money to get the property “rent ready.” You might have to paint, take care of the landscaping, and make some renovations to the property. You also have to have an emergency fund for the property. It’s inevitable that something in the house will break and repairs will need to be made, so you need to be prepared for this. One thing that many people overlook are capital expenditures. Sure, paying for small repairs are one thing, but are you financially ready if you need to replace the roof or the water heater.
Another decision you’ll have to make is whether you want to manage the property yourself or have a property manager do it for you. You’ll save some money if you take on landlord duties yourself, but you might also be dealing with a lot more stress and hassle. If you choose to go with a property manager, make sure to interview them to make sure they are the right fit. Also get a list of any fees and charges they may have. Whether you decide to hire a property manager and manger the property yourself, the most important thing is to properly screen the tenant. If you have property manager, he or she will screen the prospective tenant but you will have the final say as to whether you want to rent to that person. A good tenant will make your rental property a dream, while a bad tenant will make it a nightmare!
Thanks for sharing Andrew. The real estate game is a fascinating yet difficult game. I have a house that I rent out to a few friends and it’s difficult to balance all the different personalities and factors that come into play.
There’s a part of the house where the pipe will freeze if things get too cold. Also, the windows aren’t the best, so could need repair. While the income stream is nice, there are many repairs I could do that would make the house spectacular…
So you’re “house hacking?” That’s awesome! It definitely hard to deal with different personalities…not sure if it’s easier or harder since they’re your friends also.
I totally agree with you. Rental can make you a big profit, but it can also ruin you financially. But I guess it’s a risk everyone has to take to make money and build something financially sound in the long run.
I hear people say not to rent to friends all the time. But it can be a tricky situation to turn down a good friend when they want to rent from you.
I don’t think that the rental I bought would ruin me financially if the investment went bad. Sure, there would be some financial pain but I made sure to invest in something where it wouldn’t ruin me if it failed. Plus, there are safeguards to put in place to try and lessen that risk.
Great post, Andrew! I may have a personal announcement on this very topic soon. 😉 You make a very important point here – ” Real estate investing is NOT a get rich quick scheme”. I think of the infomercials and ads I’ve seen out there that claim this and I cringe.
Thanks Amanda! I know you guys were looking into investing in rental property. Looking forward to read more about it.
Great overview Andrew. I don’t think real estate investing (another physical house) is for me. I love reading all the success stories and some of the crazy tenant stories too, but just not for me. I stick with my index funds. 🙂
Yea, it’s tougher for us folks in the Northeast…it’s too expensive! I’m a big fan of index funds as well and have most of my money there.
I think the 1% rule is solid. The challenge is that its hard to find properties that adhere to that rule – in most areas. So I find that a lot of people lower their standards on this point hoping for value appreciation to make up the difference. Bad idea. It becomes so much more of a risky proposition when the cash flow numbers don’t work out great right at the start.
I don’t think I’d ever find something that meets the 1% rule in the NYC metro area where I live. I would be a little flexible with that rule if I could find something close to the 1% rule here in NYC since appreciation is awesome…though I definitely wouldn’t invest in it if there was negative cash flow. I can’t take that risk.
Thanks for sharing Andrew!!! I definitely wouldn’t mind investing in real estate but unfortunately the market in the DC area has heated up and hadn’t made much financial sense at this point. So in the meantime I will sit patiently until the right property falls into my lap 🙂
How’s the areas a little farther outside of DC in Virginia and Maryland? I heard a podcast episode on Biggerpockets about an investor in invests in the Maryland area and does pretty well.
I’ve heard a number of horror stories with renting as well as stories on the other end of the spectrum where people have had good renters for upwards of a decade(!) with little maintenance or work needed on their part. I’m hoping to turn our current home into a rental in about 5 years and ideally will never sell this house. Looking forward to having some income in retirement from it as well!
That’s awesome that you are currently renting a part of your house. I think it’s great to have a tenant help pay some or all of your mortgage. Good plan to rent it out in the future too.
hi there- I am a newbie here.
Ive also been accumulating rentals out of state (actually- out of country) focusing on fixer-uppers in “good” neighbourhoods.
I made so many dumb mistakes on the first house purchase. But in hindsight, it was such a practical learning. Getting smacked 100 times is a bigger learning curve than reading 100 books. Cheers.
Wow…investing out of the country! Interesting, I’d love to hear more about it and in what countries. And you’re right…learning through experience is important.
Do you have any hard rules when it comes to establishing an emergency fund?
Are you talking about for real estate investing? If so, I would absolutely be putting aside a portion of monthly income toward repairs etc. Starting out with a larger fund is better if you can swing it after down payment and closing costs. That, and knowing what repairs will need to be done before you close will help too. Does that help?
Yeah, of course. Thanks!
I actually asked my uncle, a real estate investor in Orange County, this same question. He doesn’t.
If a house goes belly-up, he’s screwed. And he likes it that way lol.
Personally, to me it is worth the money to pay a management company to take care of any rentals I acquire. I just can’t fathom running to and fro when someone’s heater kicks or window won’t open, etc.