One of the wisest financial decisions you can ever make in your lifetime is to start your very own rental property business. There are many benefits that a rental company has to help you live the life you’ve always wanted. It’s the best way to acquire financial independence reasonably early in your life. If you’ve decided to start your business, then this article is for you.
Here are eight proven steps for the best rental property business.
1. Learn what you’re doing BEFORE you do it.
Don’t plunge right into buying your first investment property if you only have the gist of things. Get a feel for the market first and develop a clear understanding of your financial situation and goals. It is essential to get a bird’s eye view of the rental business space and the many laws surrounding it as they can vary widely by states. Once you have a clear idea of what you’re getting involved in, you are ready to begin investing.
One of the variables you’ll want to consider is the amount of time and effort you will need to put into this business. It would be best if you approached this business with a clear mindset to avoid falling into common pitfalls.
2. Understand that a rental property business is not a hobby
Do you want this endeavor to pay you like a hobby, all haphazard and unpredictable, or do you want it to offer a return-on-investment like a structured and efficient business? The IRS will consider this to be a business, so it’s vital that you do as well.
As both a business owner and a real estate investor, the tax code opens very wide with far more possibilities than a W2 employee can leverage in terms of deductions.
Consulting a CPA (Certified Public Accountant) who specializes in tax strategy will be able to help you maximize your return on investment.
3. Be prepared for the legal ramifications of owning a business
If you keep this rental property in your personal name, then any potential legal issues resulting from your ownership of the house can affect your personal assets as well. Savvy real estate investors employ multiple strategies for legal protection and corporate veil protection.
The following is not meant to be legal advice. Consult with an Attorney specializing in Corporate Law before employing any of the following strategies.
Many states allow the formation of a REPT (Real Estate Privacy Trust), also known as a Land Trust as the first step in separating your personal property from business assets. A robust secondary layer then would be to hold your land trusts in an LLC (Limited Liability Corporation).
Don’t panic if you already have rentals in your name. Once you’ve established the proper entities, you can file a Quitclaim Deed to transfer the property into the appropriate legal structure. If you have a mortgage on the property you may quitclaim the property into a trust without triggering your lender’s Due On Sale clause as this type of transfer is protected under the Garn-St. Germain Depository Institutions Act.
If you think that insurance alone will cover your interests, then I encourage you to sit down and read an insurance binder. There are a few pages about what the insurance company will cover and far more pages about what they won’t.
4. Set realistic goals and milestones
While a rental business, when appropriately managed, is a surefire way of achieving wealth, the journey may be reasonably long depending on your situation. You will need some time before going through the relatively steep learning curve to become successful. As is valid for everything else in life, this is not a get rich quick scheme. Start by defining achievable, realistic milestones, and then set out to prepare a business plan to facilitate those goals.
I recommend that you begin by knowing where you’ll need to end up. After all expenses (PITI, property management, and reserves), a single-family home rental property should cash flow anywhere between $200-300 per month. If you think that’s impossible, then you probably live in a market where home prices are relatively high compared with the rest of the United States.
Start by completing a budget and determining the total of your monthly expenses. Then you’ll do some simple math. At an average of $250 per home, or “door,” how many doors will you need to cover your monthly expenses? For example, if your monthly expenses are $5,000, then you’ll need 20 doors to become financially independent.
True financial independence occurs when your passive income exceeds your monthly expenditures, so then you won’t have to trade time for money anymore.
Once you’ve determined your goals, then you can work on developing a sound strategy for achieving it based on your financial situation.
5. Find the right investment property
Finding the right asset can spell the difference between success and failure early on. Locating favorable investments requires sufficient knowledge of real estate markets, including variables such as location, having easy access to public transportation, proximity to quality schools and hospitals, and more.
Many beginners exhibit fear about buying into a market as they’re unsure of whether it’s an up or down market and how long it will last. Nobody wants to buy at the wrong time, so they get paralyzed by over-analyzing opportunities and fail ever to take any action.
There’s a simple way to get you out of your way! Buy-and-hold investors care less about the value of the house and more about the return on rents. I wouldn’t panic if I buy a house for $100k and then the market price drops to $80k the next year as long as I can keep the rent the same (or preferably raise it).
Employing the 1% rule here is an excellent measure of whether or not you’re looking at a quality investment. Basically, if you buy a house for $100k, you should be able to charge at least $1,000/month in rent for it to be a sound opportunity. If the property is $150k, then at least $1,500 and so on.
Where many new investors get into trouble is by overpaying for a house or investing in the wrong market. Renting out a home that’s worth $700k for $2,800/month is a definite way to make sure that you keep working a job to generate income. That investor could sell the house and use the proceeds to buy 20+ doors with significant cash flow. Why keep all of your eggs in one basket?
6. A good property manager is worth their weight in gold
Early on, you’ll want to decide if your aspirations of wealth revolve more around being a landlord or an investor.
- Do you want to screen tenants yourself?
- Do you know how to legally interpret the Fair Housing Act?
- Do you know where to run credit and background checks?
- Do you know how to interpret wage and tax statements to determine ability to pay?
- Do you want to answer potentially dozens of inquiries about property showings?
- Do you want to answer that 2 AM phone call saying that the heater is out and it’s below freezing outside?
- Do you want to be subject to a personal enough relationship with your tenant so that if they can’t pay on time, it affects your ability to make business decisions?
- Do you know how to evict a problem tenant?
- Do you have time for all of the things mentioned above?
Property managers solve for all of these concerns and more. The only downside is that you have to pay for their services. They will do everything mentioned above plus collect the rent and hire contractors when repairs are necessary. Expect their fee structure to relate to either a percentage of the lease payment or a flat monthly fee negotiated at the inception of their representation.
I have two thoughts about paying property management fees.
- If you’re buying the house correctly, as discussed above, you’re already accounting for their fees when you purchase.
- Even if you want to be the landlord to save money, the IRS will not let you deduct ANY of the time that you put into it. As the owner of the investment property, you don’t get to value your time where taxes are concerned, but you can write-off 100% of property management fees.
Have you ever bought your own minimum wage job before? Welcome to being a “landlord.”
Obviously, you’re going to operate your business how you choose. In my opinion, though, passive income should be precisely that. Why would you want to invest in real estate merely to get into a whole new rat race of trading time for money?
7. Making an early estimate of returns
Before your rental business can take off, you should have the right numbers at hand. Find out how much cash flow the property can generate.
- What will be the cost of expenses needed to run the rental property business?
- Principal, Interest, Insurance, and Taxes (PITI)
- Property management
- Legal/Tax expenses such as entity structuring and a CPA.
- How much will I need to place in reserve from rent to account for known and unforeseen problems?
- For example, a new water heater every eight years, a new roof every 20 years, repaint and carpet every three years
- For most single-family homes $75-100/month should cover a reserve
Gaining an understanding over these numbers will ensure you stay profitable for a long time to come.
8. Purchasing your first property
Now that you understand the numbers, it’s time to buy your first investment property. You can do this by using your own cash if available and/or utilizing financing options from lenders. If you’re willing to live in a multi-family for at least a year, see why FHA loans are amazing for growing your rental portfolio. There are ways to purchase rental properties even if you have zero money down. There are also ways to buy them with retirement accounts where all of the returns will compound tax-free!
There are quite a few more details that we left out, but the basics should help you get started. Any questions or comments? Please let us know in the comments section below! If you learned something new, please share the link with your friends.