Rental Property

Rental Property

A rental property passive income model is one where people purchase a home (outright or with loans) for the purpose of generating stable rental income. These are most attractive when the economics make sense – low housing prices, high rental prices, coupled with low interest rates and stable demand.

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Steps To Make It Happen

Finding a Realtor

Research

The first step to owning a rental property is to research, research and research. We recommend to start learning as much as possible about the housing market, the rental market, anticipated home appreciation, taxes, rental demographics, etc. In addition to conducting research online we recommend getting in contact with someone who has experience in the housing market.

There are may different real estate companies that can help when understanding the market and looking at houses. A few of the most popular ones are:

  • Coldwell Banker
  • ReMax
  • Century 21
  • ERA

 

Choosing a Realtor

Things to consider when picking the right Realtor:

  • Experience in Market – Understands the historical trends in the market that you’re looking in
  • Excellent Customer Service – Somebody who wants to build a long term relationship and is willing to help you out with the rental. For a few of our rental properties our realtor has helped to be our local manager and also help with re-painting our walls.
  • Trust – Someone who you can trust to give you the best information and give you the best recommendations in terms of location, price, and rental value.

*Note – All our investment properties are in the state of IL, and the Realtor fees are paid by the seller. So it’s completely free from the standpoint of the buyer in looking for houses. (Although one could argue that the Realtor fees are already baked into the asking price)

Determine if a Rental Property Makes Sense

Looking at Homes

After doing research on the market, properties, and getting a good Realtor it’s time to hit the pavement and look at homes. In evaluating whether or not to purchase a property for the purposes of rental income we recommend to first get a sense for whether the housing economics make sense in the area that you are in. The things that we recommend getting a pulse for are:

  • Average Home Prices – This is the baseline both in terms of how much of a capital outlay the rental property may require (generally 20% down with good credit) and also a baseline for how to measure the % return.
  • Rental Market – The two metrics that we recommend looking into are how much homes are renting for and also how long they are on the market before getting rented. Both will have a direct bearing on potential profitability.
  • Taxes/Home Owner Association (HOA) Fees – These will have a direct bearing on how much it will cost to run the rental property. What we’ve found is that different subdivisions can have different taxes and also HOA fees.
  • Average Home Price Appreciation / Depreciation – This is the % amount that homes have historically appreciated or depreciated in the area. Generally we recommend areas that are appreciating as any change here effects what we’d be able to sell it for in the future and directly impacts the amount of equity that we get out of the transaction.

Overall these are what we feel are the most important pieces to get a gauge for when looking at purchasing home for rental purposes, and think of it from the standpoint of revenue potential and cost.

 

Profitability Potential Calculator

Here is a calculator that we’ve created that can help determine the profitability of a rental property:

Inputs:

Outputs:

*Note: When investing in a rental property one thing to consider is the opportunity cost. It is the principle that the money that gets invested into housing could be invested in other things, one thing that we need to consider is to make sure that investing in housing is a better use of the funds than other options. (Included in calculator as well)

Search

Finding the Perfect Home

Once you’ve decided that it makes sense to own a rental property the next step is to find the perfect home. This is both the most fun and most frustrating part.

When looking for the perfect rental property we recommend looking for the following things:

  • Location – Is the home located in a good area? Are there good schools in the area? Is the area still developing and growing?
  • Market Trends – Are homes in the area gaining or losing value?
  • Rental Marketability – Is the home suited for the target renter? (i.e. 2 – 3 bedrooms with 2 bathrooms)
  • Effort Needed to Get Home Rental Ready – Is the home ready to rent after purchase or how much is required to get it rental ready?
  • Rental Prices – What are rental prices in the area?

Take the time to understand the rental market and find the right home. Spending the time upfront will help avoid many headaches and help set you up for a successful rental.

 

Submitting an Offer

Once you find the right home, it’s time to submit an offer. Our personal advice is to take into account the asking price, how long it’s been on the market, and how badly you want the place into consideration before submitting an offer. If the property has been on the market for a long time, chances are pretty good that an offer much lower than the asking price will be considered. Even for properties that have not been on the market very low, it may also be a good idea to start low. Generally what happens is that a seller will gather bids shortly after putting the home on the market. If the seller has multiple offers that they want to consider, they’ll go back to each of these offers and ask for a final and best offer. This is when to offer the best offer that we’re willing to pay for the location. If there are no other bidders in this scenario, it’s quite likely that seller would counter-offer until an agreed asking price.

Closing the Deal

Now that we’ve found the right home at the right price, the next step is complete all the necessary steps to work towards a closing date.

Getting a Loan

When looking for a loan we suggest a few options:

  • Realtor Suggestions – Most realtors will have a contact in the mortgage business and some may even have a mortgage consultant that can help
  • Banks – Wells Fargo, 5th 3rd, US Bank, and Chase Home Mortgage
  • Online – Quicken Loans and Lending Tree

Most of these are good way to start, our personal preference is to work with someone that you can meet in person. It was worthwhile for us to have someone who we could ask questions to and to get their help with finding the right mortgage.

After contacting these mortgage companies, they’ll ask for your social security number to run a credit check for your credit score. Generally a credit score of 750 and above should get you the best mortgage rates.

When finalizing the rates, make sure to ask the following questions to ensure that you’re getting the best deal for your financial situation:

  • Downpayment % – In general most banks require about 20% down, and some banks will give a rate credit the more that is put down as downpayment up to a certain %.
  • Money Paid / Money Back – You can pay to lower the interest rate or get paid by increasing the interest rate
  • Length of Loan – Loan term can have an impact on which the interest rate, so make sure to ask for the interest rate with different loan terms

A quick note here is that we recommend getting a fixed interest % loan and that also includes the option to repay early. As the purpose of the home is for a rental property the fixed interest % will help to lower the risk by locking in the mortgage cost, and the option to repay early gives owners flexibility to exit the business at any time.

 

Purchasing Insurance

If a loan is utilized for purchasing a rental property, insurance is required to be purchased with the home before a mortgage company will release the funds. Insurance generally runs $200+ per year and will help cover external and internal damage depending on the terms of the coverage. We have utilized Geico as our insurance provider for our properties as they were the easiest to find online and feel that they do a pretty good job, are easy to work with, and timely.

Securing a Lawyer

Lawyers generally run about $300-$500 and are well worth the price. When spending a large amount of money on a house, it’s nice to have the security that all the paperwork has the i’s dotted and t’s crossed. Also in case things go south for one reason or another, it is nice to know that someone will help manage all the paperwork

 

Home Inspection

A home inspection generally runs about $300-$500 as well and our experience is that these are well worth the price as well. Anything that gets discovered during the home inspection can be negotiated with the seller. Again the stance here is that when spending a large amount of money on a home, paying the extra $500 is worth knowing that there is not something materially wrong with the property.

*Note: At one of our potential properties to purchase we discovered mold during the home inspection phase and the seller wouldn’t cover fixing the mold issue. There was a small water stain on the ceiling about the size of a tennis ball that we suspected may have been from water damage, and were quite glad that we had utilized the inspector. Generally we view the property inspector kind of like insurance on the condition of the home.

 

Close

After completion of the steps above, closing should be fairly straightforward.

*In the instance of short sales or foreclosures getting to closing can be a journey and sometimes may never get there. Each short sale and foreclosure seems to be it’s own animal and can be fairly unpredictable. Here’s a list of possibilities:

  • Close Quickly – the bank agrees and submits the paperwork for a quick close
  • Re-negotiate – the bank comes back and re-negotiates the terms of the deal, sometimes multiple times
  • Close Slowly – the bank takes time to wrap up paperwork and close could be 1 year later or more
  • No longer for sale – the bank decides that the home is no longer for sale

Generally short sales / foreclosures will have a better price in the market. Our recommendation here is that we may be able to get a better deal, but to be prepared for the unpredictability of what may happen.

Renting Out Home

Now comes the most rewarding part,  renting out the home and generating passive income.

Finding a Tenant

Realtor – Hiring a realtor and having them list it within their internal system. The realtor will do all the work in terms of listing and showing the place. They’ll also help run background checks and the credit score of applicants. What we have found is that folks with a credit score greater than 650 are the best tenants to rent to as they are the best about paying on time. One other benefit is that they will help to draft the rental contract so that you and the tenant only need to sign the paperwork. The downside of hiring a realtor is that they generally will charge one month rent + a small marketing fee. Our recommendation is that if it is your first time finding a tenant it may be worthwhile to have a realtor help walk through the process.

Craigslist – Listing the home on craigslist can be hit or miss depending on the tenant. It’s free but there is downside potential of getting a bad tenant which can be a huge headache. Most states have laws that make it hard to evict a tenant even if they do not pay on time. For example in Illinois it can be around 6 months before the tenant can be evicted. When going with this route, it may be worthwhile to run a credit check online (usually around $20) and also meet the person before renting your home to them.

Word of Mouth – Finding a tenant through work, friends, and family can be a reliable way to find tenants. Depending on how well you know the person it may not be necessary to even sign a contract. The likelihood that they don’t pay rent or mess up the property is quite low as you all may be in social circle. Generally they are also the easiest to work with and are quite reliable.

Zillow: Zillow is also an option when it comes to listing your property. It specializes in the home sale and purchase business and is also a platform for rental properties. The upside here is that Zillow is free, and similar to craigslist recommend that potential landlords run a credit check and also meet potential tenants before renting out the property.

 

Rental Contract Negotiations

In terms of the final contract negotiations, anything can be on the table. For example we’ve rented to tenants with lower credit scores but required a downpayment of 2-3 times the monthly rental. For a few renters we also increased the late fee to 10% of the monthly rental price as we were worried that they may pay late each month.

For any piece of the rental contract, make sure to negotiate the terms to something that you are comfortable with, as at the end of the day you want to generate income and also make sure the home is in great shape. (Negotiation terms can be on price, rental duration, payment date, late payment amount, down payment amount, repairs and maintenance, furnishing, etc.)

 

Making it Passive

Now that you’ve found a tenant and started generating income, one of things that we believe in is to start making things more efficient and easier to run. A couple of suggestions here:

Automate Rental Income/Expenses – We recommend setting up Chase Quickpay or a service like it to for online rent payments. Chase Quickpay is an online banking service that allows funds to be transferred from one bank to another via the click of a button. It makes it easier for the landlord and the tenant as payments are all done electronically and helps to eliminate the need for sending checks or rent pickup. The service is also free if either the landlord or the tenant is a Chase customer (most banks have a similar service, so it may be worthwhile to inquire about your banks online payment system)

The other piece of automation is the expenses side. Our primary expenses each month are the HOA (Home Owner Association) Fee and the monthly Mortgage. We have these set up as an auto deduction each month, and has helped us eliminate the need to remember to pay as well as the work associated with paying these.

Finding a Handy Man – One of things that will be inevitable when owning a rental property is the need to fix something at the rental home. Whether it be something small like trash disposal gets clogged, or something big like the water heater goes out. We have found it quite convenient to work with a handy man that we trust and to have help out when our tenants need anything fixed. It makes it convenient to work with one person who can address most fixes, although for large items you may still need to look for companies to come out.

At this point anything that you can think of to help make it easier to manage, and to save you time in managing will make it more passive. After everything is set up we find that we probably spend on average about 1 hour a month on the rental property as well as work through anything that breaks (usually 1-2x a year).

We hope that these steps help give you a primer on generating passive income from real estate and wanted to leave you with the following quote “Real estate investing, even on a very small scale, remains a tried and true means of building an individual’s cash flow and wealth.” – Robert Kiyosaki author of Rich Dad Poor Dad

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