Rental Property Investing: Your Paycheck For Life
John Stuart Mill, the 19th century British political economist, put it best: “Landlords grow rich in their sleep.”
Becoming a landlord is a powerful wealth-building strategy too often ignored by investors. In addition to its inherent advantages, rental property is a great way to leverage the current real estate boom. Below, I’ll show you the right (and wrong) methods to buying rental property.
The conventional way to profit from real estate’s resurgence is to buy stocks such as Realty Income (NYSE: O), a real estate investment trust (REIT) that’s a holding in the Income Portfolio of our flagship publication Personal Finance. Since we added Realty Income to the portfolio on October 23, 2013, the REIT has generated a total return of 68.41%.
Write your own paycheck… for life.
With a juicy yield of 4.11%, Realty Income is a rock-solid income payer. But you should also diversify into other asset classes.
If you do it right, owning rental property is like writing your own paycheck in retirement. After all, passive income is one of the surest paths to financial independence.
Rising home values are pricing a lot of people, especially millennials burdened with student debt, out of the housing market. More than 8 million net new households were added over the past decade in the U.S., and renters accounted for all of them. Home ownership in the U.S. has dropped to 63.5%, near a 48-year low.
These trends are in turn jacking up rents around the country. Welcome to the rise of “renter nation.”
I’ll show you how to turn renter nation into a steady stream of retirement income, by getting tenants to send you a check every month. As a landlord, your tenants are paying off the equity, while you enjoy home price appreciation and a bevy of tax breaks.
Becoming a landlord is no game…
As you might imagine, becoming a landlord involves a bit more than just plunking down little plastic houses and waiting for someone to land on your square, a la Monopoly.
If you overpay for your property, you’ll have a hard time recouping your investment. When you pay too much, you’ll immediately find yourself in a money-losing hole from which it could take years to recover. Even worse, you might never get back your money at all.
First, do the math. The main factor to determine is whether you’re overpaying for your property. Pay the right price and you’ll see the benefits for years. On the flip side, if you’re overpaying, not only will you never profit, but you’ll actually start bleeding money as your costs outweigh your income. That’s a scary thought.
Luckily, finding out how much to spend when evaluating property requires using just two simple yardsticks.
The first down-and-dirty metric to determine is something called the gross rent multiplier (GRM):
Gross Rent Multiplier = (Selling price) / (Gross Annual Rental Income)
When calculating your GRM, make sure that for your gross annual rental income you factor in not only what your tenants will be paying you, but any incidental money that you may receive, such as payments from vending machines, parking spaces and laundry facilities. Coin-op cash can go a long way.
Although the GRM doesn’t tell you much about an individual property, use it to compare several similar properties in the same area. Look for a smaller GRM in comparison.
Here’s a rule of thumb for evaluating an individual property: If your prospective property’s selling price is more than seven times your gross annual rental income, you will end up losing money. Your income from the rental won’t be enough for both your mortgage and your operating expenses.
And forget assuming that by paying more as a down payment you can improve your cash flow. You’d be better off putting that extra money into safer investments such as Treasury bonds.
The other yardstick to use is the capitalization rate:
Capitalization Rate = (Net Operating Income) / (Total Investment)
Determine your net operating income by subtracting your operating expenses from your prospective property’s yearly gross income. Make sure that you count any costs you’ll pay while you own the property — maintenance charges, insurance, utilities, property (but not income) taxes, etc. — in your operating expenses.
It’s crucial that you determine the capitalization rate on a given property because this will let you know how quickly a rental property investment will pay for itself. A property with a capitalization rate of 10% will take 10 years to pay for itself. It’s a good idea to keep this rate at around 8%.
When calculating your metrics to evaluate a property, make sure that your numbers are as accurate as possible. It’s very common to be so excited about a potential real estate deal that you even lie to yourself to see the numbers you want. But that won’t do you any favors.
Also remember that your best bet for investing in rental estate is by purchasing multifamily houses or multi-unit apartment buildings. You’ll get way more bang for your buck than you would from a single-family home or condo unit.
As you can see, becoming a landlord could be the smartest, safest investment you ever make … as long as you follow my simple guidelines.
Got any questions about how to become a landlord? Send me an email: email@example.com — John Persinos
There’s ANOTHER way to generate a lifetime of cash…
Maybe buying rental property just isn’t your thing. Or maybe you’re intrigued by the idea, but still want addition sources of income.
Our income expert Jim Fink, chief investment strategist of Options For Income, has fine-tuned a simple investing technique that generates steady income, in up or down markets.
Jim’s returns are so reliable, they look just like a paycheck.
But instead of following the 9-to-5 grind in a claustrophobic office building, you can sit back at home and let your invested capital do all the work for you. That’s a home-based paycheck that any investor should love.
We explain exactly how this simple moneymaking technique works, and what you need to do to earn your first “paycheck” using it.