Why You Should Invest in Rental Real Estate
Mark Ford|July 10, 2020
Let’s talk about one of my favorite wealth-building strategies: investing in rental real estate.
To be a successful rental real estate investor, you need three things: time, money and knowledge.
This is true of most investments. But with rental real estate, you don’t need a lot of any of them.
You can start getting a return on your investment immediately, like stocks and bonds. You can get into your first deal with as little as $10,000, which is more than stocks and bonds, but less than many other asset classes.
And you can acquire the knowledge you need to be successful in an amazingly short period of time because real estate is just not that complicated.
Due to the coronavirus crisis, I believe many parts of the real estate market will hurt over the next few years – principally, the high end.
Why the high-end market? Well, I believe there is a good possibility that the shift toward working at home will continue, and that will temporarily drive down income from office buildings and reduce the size of that market long term. I have the same long-term concerns for middle-level retail real estate too.
However, I’m not worried about investments in our residential properties even though my partners and I have had some rent deferrals and vacancies recently.
I’m also not worried about the apartments I own in working-class and middle-class neighborhoods or about my investments in the dozen or two office buildings whose tenants are companies I own or control.
I’ve been investing in stocks, bonds and businesses for more than 50 years. And I’ve been earning an outsized income for more than 30 years. I’ve been investing in real estate for 20 years. And yet today, it accounts for the largest share of my net worth.
More importantly, except for my first investment in this sort of real estate, I’ve never lost a nickel investing the way I do. It’s been an easy, uphill ride for 20 years.
If you are interested in that sort of experience, then you will be interested in using a strategy of investing in real estate that is similar to mine. And that means three things:
- Stick with rental properties.
- Buy only when the prices are right.
- Trade up from starter investments to larger ones.
Let’s cover the basics: the money, the knowledge and the time.
I suggested above that you can get into rental real estate for as little as $10,000. How, you may wonder, did I come up with that number?
In my experience, the easiest way to get into rental real estate is to buy single-family, three-bedroom, two-bathroom houses in working-class and even lower-income neighborhoods. In most parts of the country – except when prices are skyrocketing – you will be able to buy a house like that for $100,000.
To get a loan on a $100,000 property like that, you’ll have to put down $20,000. And then there are other costs, including closing costs. Let’s call that another $4,000. So you’ll need $24,000 in cash to get started.
You could do that on your own, if you had the cash. But that’s not how I got started. From day one, with every business I could, I invested along with a partner. I wanted partners to reduce my exposure, but also so that I had additional brainpower to make the buying, selling and managing decisions.
So the play would be to find someone you trust to come in with you and give him a 50% interest in the property for an investment of $14,000. The extra $4,000 covers your fees for putting the deal together.
Of course, you have to know someone who (a) has $10,000 to invest and (b) is trustworthy. People who are trustworthy surround themselves with trustworthy people.
If you are trustworthy, finding a partner won’t be a problem.
Another option is to find a bank to give you a mortgage at 10%. Can you get a loan with a 10% down payment? It is possible. But I don’t recommend such loans. The traditional 20% requirement is there for a reason. It makes you think harder about the value of what you are buying and treat it more seriously. This is always a good thing in business.
The most important knowledge you need to acquire is about the relative values of single-family homes in the neighborhood(s) you want to invest in.
And this is easy to do. Simply spend some time looking at and responding to local real estate advertisements.
Read the listings. Get on a local realtor’s free email list to stay in the loop on properties that come to market. Talk to brokers. Visit a dozen or so homes that are for sale. Before you know it, you’ll have an instinctive feeling for how much you should pay for any particular property in your area.
You also have to learn what you can expect to earn by leasing out the kind of houses you are shopping for. This, again, is as easy as pie. Look at the rental listings in your area. Talk to a broker who specializes in rentals. Browse websites like Zillow, Trulia and Craigslist.
A week or two of evenings or weekends should get you up to speed on purchase and rental values.
Once you have done that, it’s time to look for a property to buy. This process should take less than 40 hours. You may not be able to cram those 40 hours into a single week.
That’s because your objective is to buy at the right price. And not every house that comes to market is priced right.
Success in real estate in the short run is dependent on buying right. (In the long run, this is much less important.)
There are times when buying right is easy. From 2009 to 2013, for example, this was the case. Lots of inexpensive properties and inexpensive, easy-to-qualify-for financing were available.
Other times, the good deals are few and far between. They exist, but you have to go farther (perhaps even to another state). Or you have to take on a bit more work (buying properties that need more in the way of repairs).
When conditions are tougher, I’m still a buyer. I simply recognize that I won’t be able to buy as much because there isn’t as much on the market.
Plenty of properties will eventually cycle back onto the market. But there will also be plenty of guys out there with money who will be competing with you for the best deals. So you may have to wait a few weeks or even a few months to find a property that is priced right.
That’s okay. You never, ever want to run after any investment. There will be plenty of chances to cherry-pick individual properties over time, so don’t feel pressured.
Once you have picked a property to buy, it will take a few weeks or a month to close on it. There will be forms to fill out and contracts to sign.
Soon enough, the day will come. And then, if you are properly prepared, you should be able to get it rented in a matter of days or weeks.
Your $100,000 rental property should bring you about $15,000 per year in rent. After the cost of financing (the mortgage), management fees (you can do this yourself if you want) and rental commissions (if you need to use a broker), your net profit should be about 20% to 30% of the gross rent – so $3,000 to $4,500. Let’s say $3,000.
That $3,000 is a 3% return on $100,000. Not good. But you didn’t invest $100,000. Your partnership only invested $24,000. A $3,000 return on $24,000 is a 12.5% return. That’s better than the historic return you can get on stocks, but is it good for something more time-consuming, like real estate?
It wouldn’t be, in my opinion, except that the 12.5% return is not the end of the equation. That 12.5% is the income you are getting. But there is also the appreciation you are getting on the rising value of the property itself.
The historic appreciation of the sort of property I’m talking about is higher than 4%, but let’s use 4% to be conservative. So on top of the $3,000 you are netting from rent, you are accruing another $4,000 return on year one, which would bring the overall return to $7,000, or a total return of 29% on your starting stake!
That’s how rental real estate can get you rich.
What’s the best investment you’ve made during the coronavirus crisis? A hot stock? Undervalued real estate? Toilet paper? Let us know at firstname.lastname@example.org.