I love the idea of owning several real estate investment properties and living off of the cash flow from the rental income.
But while I love the thought, I’m not so sure I’d actually like the things that go along with owning investment properties (e.g. tenants, maintenance, etc.).
Over the weekend I did some reading about starting up real estate investing, and I also had a discussion with a successful real estate investor. Here are some of the thoughts I have as a result of my research.
Shoot for 10% Return on Investment
If you’re going to take on the risk of owning property, you need to have a shot at getting a very nice return. After all, I know most of us aren’t lucky enough to have $1M sitting around in cash just waiting on the right investment property.
Most people getting into real estate usually have enough extra cash for one unit. Therefore, if you’re going to tie up a bunch of your cash in one place, you better be getting a solid return. Enough of a return so that if something goes wrong, you can still get by with a lesser return.
In his latest book, The Skinny on Real Estate Investing, Jim Randel suggests only dealing with investment properties that can produce at least a 10 percent return on your investment.
As an example, let’s say you are looking at a piece of property that will provide $20,000 in rental income annually. Given that you have expenses (taxes, insurance, maintenance, misc.) of $5,000, you will have a net operating income (NOI) of $15,000.
Given this NOI, you should only expect to pay $150,000 cash for this property. Any more than that and you run the risk of problems with this property infringing on your ability to make a decent return (above 7%).
Of course, when you factor in financing on this property it changes the numbers in your favor (especially with today’s mortgage rates). Sometimes the leverage you get from borrowing is enough to dramatically increase your return.
But it also makes the entire transaction more complicated and stressful since you are now taking on debt, in my opinion.
I like the 10% approach. It seems conservative and it helps take the emotion out of the decision to buy.
If the numbers add up, then you are free to pull the trigger. If not, then it’s easy to walk away. I would bet that there aren’t a lot of 10% properties in my neighborhood. These types of properties are hard to find, I would imagine.
But that’s what makes them a good investment, right?
Look for Investment Properties Where You Can Add Value
A good real estate investor looks for ways to add value to a property so that the return on investment will go up.
When I spoke to the successful real estate investor, he shared with me how he was adding value to one of his current properties. He purchased a plot of land on the corner of a couple of main roads in his town.
The property was in a floodplain, so it was basically useless. However, he told all the local construction companies that they could begin dumping their unwanted earth and concrete on the land. In a year’s time, this former flood zone had become a nice piece of property using this free material.
He is now contemplating placing a gas station on the land given its central location.
The jury is still out on whether he can make this work. But I was impressed at his ability to take something that most people saw as useless and turn it into something of value by using free resources.
The lesson to be learned here is to find properties where you can add value. Is there an extra space that could be rented out on the property? Are there small, low-cost improvements you could make to the property to increase the rent?
Obviously, there is so much more to think about when it comes to investing in real estate properties (e.g. how to evaluate potential rents, how to find good tenants, do you use a management company, etc.). But I liked these two takeaways because they force you to evaluate the property from a strategic perspective upfront.
What do you think? Would you ever like to own rental property? Do you currently own some? If so, what do you like about the process?