There are many strategies for accumulating wealth, and one of the most popular is to create streams of passive income. Passive income allows you to earn money around the clock – even when you’re not working.
At Addition Financial, our members sometimes ask us for advice about buying rental property. Since an investment in real estate can help you to plan for retirement, we thought it would be helpful to list some strategies for acquiring and managing rental properties to earn passive income.
We’ve provided the financial information, and we also reached out to some real estate investment experts to ask for their advice. Here are seven strategies for you to try.
#1: Find a Mentor and Shadow Them
Our first strategy is one that we think everyone should implement before buying their first property. It comes from Alex Capozzolo, the co-owner of Brotherly Love Real Estate. He told us:
“My advice to any beginner real estate investor would be to find a mentor. That is how I got my start in the industry. Taking classes is great, and watching videos on YouTube can be very useful, but nothing is more educational than doing. Find a mentor that is doing exactly what you want to be doing, and offer to work for free in exchange for experience. Many investors are extremely busy, and even though a free coffee meeting sounds nice, it is difficult to schedule. Add value to the investor as much as you can, and the first-hand experience and mentorship will pay in dividends. This applies to both investors who want to acquire rental properties, and people who want to go into property management.”
We suggest joining local real estate groups to find a mentor. Ideally, you should find someone who makes you comfortable and is investing in the kinds of properties you want to buy. That way, you’ll have an opportunity to get practical experience before buying rental property.
#2: Stay Local
The next strategy you should consider is buying only local properties until you have created a steady stream of income. With local properties, you’ll have an easy time keeping an eye on your investment. You can easily drive by or make a personal visit whenever necessary.
Another advantage of staying local is that you can choose to manage the properties you buy instead of hiring a property management company. Of course, there are some risks associated with property management, especially if you’re someone who doesn’t have experience with maintenance, repairs and the legal aspects of property management.
Managing local properties may also be less expensive than managing properties in another city or state. You won’t have the same travel expenses you’d have if your investments were spread out, and it can also simplify things like taxes and utilities, because you’ll be dealing with the same companies.
#3: Focus on Rental Income
Another strategy that we think every new real estate investor should keep in mind is to buy rental properties where the rental income is at least 1% of the total purchase price of the property.
That means if you bought a small apartment building for a million dollars, you would need to charge at least $10,000 in rent each month for the investment to be financially viable. For existing rental properties, you should learn what the current owner charges and also, do an analysis of the market value of rentals in the area where the property is located.
Another way to analyze the financial value of an investment is to make sure it will generate at least 15% ROI cash on cash. That means if you had a down payment of $100,000, your investment should generate $15,000 in income every year.
You can calculate the ROI by subtracting your mortgage payment and expenses from the total rental income generated by the property.
#4: Outsource Property Management
If you’re someone who has no experience with property management, then your best strategy may be to outsource to an experienced management company who can take routine tasks off your hands.
Greg Bond of Renovation 320 says:
“I would highly recommend that beginners do not go into self managing these properties. First, you will have a big learning curve on tenant placement, leasing contracts, property maintenance and inspections, rent collection, etc. For 8% of monthly rent you can hire professionals to do this work for you, and if you truly want a passive investment you should go this route.”
We think this advice is extremely useful for first-time investors and rental property owners. If you have extensive experience in property management, then you may be tempted to manage the properties yourself. However, that changes the income you earn from passive to active. You’ll be working – probably long hours – to earn the rental money you collect.
In the long run, it will cost you less to outsource the property management, because it will free up time for you to engage in other pursuits.
#5: Protect Yourself and Your Investment
When you rent homes or apartments to a tenant, you are trusting them with your property. They’ll sign a lease but it’s up to you to enforce it. And, when you put a property in your own name, it means you are liable for anything that happens to (or on) the property.
If you decide to rent properties for passive income, then it’s essential to protect yourself from personal liability. Chris McDermott of McDermott Realty told us:
“Protect yourself through a corporation so that you are not personally liable, i.e- Limited Liability Company or S-Corporation. If anything happens on the property, you are not personally responsible.”
Forming a Limited Liability Company or an S Corporation isn’t difficult or expensive. You may want to hire a lawyer to draw up the appropriate paperwork. The money you spend will ensure that you don’t end up in financial trouble because your property is damaged or someone gets injured while on your property.
On a related note, we’d add that you should make sure you have ample liability insurance to cover the property. Just as you would buy homeowner’s insurance if you bought a house, you should buy landlord insurance.
Landlord insurance covers:
- Property damage
- Liability
- Lost rent
In other words, it protects you if these hypothetical scenarios:
- A tenant intentionally or unintentionally damages your property
- Your property is damaged by a fire or a natural disaster (although you should make sure to read your policy thoroughly, since supplemental insurance or riders may be necessary to cover some kinds of damage)
- The property becomes uninhabitable for any reason
It’s not a good idea to skimp on insurance or legal protection. Protecting yourself will make it less likely that the passive income you earn won’t be taken from you.
#6: Educate Yourself
Even if you intend to outsource property management to someone, you still need to educate yourself about fair housing laws and tenant rights in the area where you’re renting. A lot of first-time landlords make mistakes that could have been avoided if they had done some research before they bought a rental property.
In Florida, both landlords and tenants have legal rights and duties. For example, it is the landlord’s responsibility to ensure that the rented property is habitable and safe. It is the tenant’s responsibility to pay the specified rent on time.
Failing to adhere to your duties as a landlord can cost you time and money. It can be hard work to keep up with necessary repairs, but it’s your legal obligation to do so.
You should make sure that any property management company you hire has a good reputation and is knowledgeable about state and local laws related to tenancy.
#7: Create Clear Guidelines for Approving Tenants
Finally, you should create and stick to clear guidelines for approving tenants to live in your rental properties.
The most common hurdle for tenants to clear is having a good credit score and a solid credit history. A high score indicates a tenant who is likely to pay their rent on time. A lower score may indicate someone who does not prioritize on-time payments.
However, the credit score isn’t the only criterion you can use to screen tenants. We strongly recommend asking tenants for references from previous landlords. Your rental application should include a space for tenants to include their rental history.
You may decide to run background checks on potential tenants. If you do, you must obtain a written consent from the applicant to do so. You can find a sample consent form here.
Keep in mind that you can charge a non-refundable application fee to cover the expense of running a credit report, verifying employment, checking references and running an approved background check.
Owning rental properties is a good way to earn passive income. The keys are choosing your properties wisely, being realistic about the how much income the properties will generate and protecting yourself by screening tenants and buying adequate insurance.
Ready to buy your first rental property? Click here to learn about Addition Financial’s mortgages for investors!
Posted on Jun 19, 2020
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