Rental Investment: Part Two

Updated: Jul 20

Identify Your Property

Once you have your amazing team in place, the next logical step is to identify exactly what the ideal property looks like for you. From my own experience as an investor and working with a number of different investors throughout the years, I have identified three basic steps to follow once your team is in place.

Step 1: Identify the property type.

If you look back at our website, I wrote a quick pros and cons article on the different types of investment properties. Each has its advantages and disadvantages. For now, if you are a new investor, a single family dwelling (think your everyday normal house that people purchase to live in) or a duplex (two dwellings under one roof) would probably be your best choice.

Location sometimes is a deciding factor. For example, when I buy properties, I like to purchase them relatively close to my other investment properties. The idea being I can do multiple service calls in the same day, or if a contractor needs to go out to the property they are able to swing by each property and correct something as needed. Additionally, I already have an advantage in knowing what kind of tenants will be looking at the property and what the typical rent will be.

Location can be used as an advantage for pricing as well. If you find a location where the average buyer may not want to live--maybe the property is close to a highway or busy road--it might be possible to get the property at a discounted price. A person renting a house will be less picky than a homeowner. Use that to your advantage.

Step 2: Identify your cashflow or other ways to make money.

We buy investments to hopefully make money, right? So come up with your plan of attack and stick to it. To me, an investment property is a 10 year plus commitment. Playing the long game allows for market volatility and helps shield your investment. I would consider anything under a 10 year term a flip. The strategy and playbook for a flip is vastly different from the strategies outlined for investment properties, and they should not be approached the same way.

I look at all of my investment properties as 30 year investments. I plan for a large payoff at the end of the 30 years, once the mortgage and the property are paid off and--aside from maintenance, taxes, and insurance--the rest goes into my pocket. This is when cashflow is the amazing vehicle towards wealth that everyone talks about. Before you get to the wonderful point where everything is paid off and you are living at a beach somewhere in South America, we have to come back to the real world.

A lot of investors think about properties by the 1% Rule. This is a pretty good rule of thumb that states that if a property is purchased for 150,000 then the rent needs to be 1,500 dollars per month. I like this because it is cut and dry, without a lot of room to mess up. When you can purchase a property like this, it will become a great investment. The mortgage will not change and your rents usually only increase after time. A number of my most successful investors try their best to stick to this rule.

As lovely as the idea is, the 1% rule is not always an easy rule to follow. In our inventory starved market of 2021, getting a property can be especially challenging, let alone getting it to rent at 1% of the purchase price. I find that properties in our market typically go up in value 6-8% per year. If you are looking at a property that is close to the 1% rule, just know that the value of that property has the potential to rise significantly over your ownership of it. As the property values rise, rent typically increases as well. Most renters understand this and have accepted it as part of life.

A second way to purchase an investment property is to look at it as an appreciation play. If I purchase a property in an area that is “up and coming” or where house values are on the rise, in a number of years the house will be able to be sold for much more than when I bought it.

This is how I like to buy a lot of my properties. Identifying a specific area that the properties are undervalued in relation to the rest of the market and allowing the property value to increase. To do this you need to understand your margins and where your money is going.

At the end of the day if you have your tenant pay your mortgage and nothing more, you are at a huge disadvantage. Properties need upkeep. Roofs only last 30 years. Cabinets and kitchens need to be periodically updated, paint needs to be fixed after each tenant moves out. Floors need refinishing after 10 years, and we are lucky to get 10 years out of appliances these days. It adds up. My rule of thumb is to put one months rent into a savings account for the property maintenance fund. Let it grow and add up, that way you don't freak out if you have to spend nine thousand dollars on a new roof in twenty years.

For me, I look at the cash I receive after the mortgage, taxes, insurance, and maintenance as a hedge against any unforeseen problems with the property. This money is a defense to any unexpected problems that may come up during the time you own the property. Play defense so that you can reap the benefits of the offense when the property has paid for its own mortgage in full. That is the most amazing part of owning a rental property. If done correctly, after twenty to thirty years, the property has paid for itself in full and will continue to bring in passive income until you decide to sell.

Preparing for the eventual maintenance brings me to the final consideration of your investment property. The underwriting of the whole deal. Think of this as building your business plan for a particular property in terms of cash needed to close, upkeep, fixing any problems upfront and mitigating problems later on.

Step 3: Identify your underwriting requirements.

This is a business. Run it like a business. This means having a plan in place before you get started looking at properties. Selecting the right investment property is very much a case by case decision, which at first glance can be a very daunting task. This is why identifying a few key factors before you go out and look at investments can reduce or eliminate decision fatigue and keep your mind clear and logical when picking the right investment.

Everyone has their own system here. No one in particular is perfect as each person has their own risk tolerance and ability to go in and fix certain items. The most successful landlords and investment purchasers go in with a written plan on what they will and will not accept.

When good investors look at a property, they have a spreadsheet that details the amount of work needed to complete the project so the home is rentable at the highest dollar amount. They will also account for the ages and life expectancy of appliances and major systems so that they can budget for expected future repairs and replacements. Some investors need to budget money to pay for handypersons to come out to the property to fix these items, some will be able to fix themselves. Either way, a good investor already has a plan in place.

Once the property has been viewed, take a long hard look at your numbers and at the property itself to make sure it works for your system. If it does not work, wait for the next one, because there is always a next one. New investors can get caught up in the thrill of buying and forget to look long term at the investment. This can be a slow and boring business, but it pays well to those who take their time and are thoughtful about the purchases they make. It can be scary at first, but so is starting any business. If you go in with the right team and the right mindset, the world is your oyster.