It’s probably the best known and most common of all real estate investing strategies. Owning a piece of real estate with the objective of earning a regular cash flow from rental income.
“Land-lording” is a concept that developed many hundreds of years ago in Europe, where wealthy property owners, with thousands of acres of land, allowed the “peasants” to live on that land and grow food to support their families. The peasants were expected to give the landlord a portion of their farming produce as “rent” in return for having a place to live. The wealthy land owners controlled all of the land, and the peasants had little, if any chance of ever becoming landlords themselves. This is generally where the concept of the “upper class” and “lower class” came from.
In modern America’s free-enterprise system, it is much easier for the “peasants” to become landlords themselves. Most of the landlords involved in the single family rental property market have traditionally been “mom and pop” investors, who’ve saved their money and invested in rental houses. The rental property business in the U.S. is where a lot of folks in the “middle class” have found a real opportunity to make their fortunes.
The rental property business is made up of two general groups: Commercial and Residential. For this article, we will be addressing the residential rental property business as practiced by the vast majority of individual real estate investors.
Residential rental properties can be individual homes, known as single family rentals (SFR’s), Duplexes, which have two units each, Triplex, with three rental units and Quadruplex or “quad” that has four separate units. Five or more units crosses into commercial territory and is subject to a different set of rules and regulations.
The basic idea with residential rental property is to rent the property to a tenant, and in so doing, earn enough income after paying taxes, insurance and maintenance expenses to show a decent return on your investment. To achieve this objective, there are several basic fundamentals that a landlord needs to insure success.
1. Tenants who can pay the rent: This sounds obvious, but one of the true fundamentals so investing success with rental property is finding good quality tenants that will pay their rent as agreed.
Some of the best rental markets include neighborhoods near colleges and universities, where students rent properties on a regular basis while attending college. Homes located in the vicinity of popular educational institutions often rent for a premium price, with the added benefit of having mom and dad to guarantee the rent. Areas with excellent employment opportunities also have very good rental demand.
One of the biggest challenges for any landlord is to keep a good paying tenant in a rental property, and avoid vacancies. High vacancy rates can be a real problem. Usually when a property goes vacant, it will result in the loss of at least one month’s rent while the property is reconditioned and marketed to find a new tenant. Landlord screening services help property owners and managers find tenants that will be reliable. It is highly recommended that prospective tenants be screened, including a background and criminal records check.
2. Keeping Property Expenses In Check: The biggest fundamental challenge for landlords is keeping property ownership and maintenance expenses under control. This can be difficult to do because to some extent these expenses are beyond an investors ability to control.
For example, property insurance and property taxes are expenses that are determined by a third party. These two items often cost at least one month’s rent each or more. I have several rental properties and in every single case, the annual property insurance premium is at or just above the cost of one months rent. Thus one month of every twelve goes to pay the insurance.
Property taxes are an even bigger issue because the local governing body can raise property taxes on a yearly basis if they so desire. Yearly property tax increases during the early 2000’s helped trigger the downfall of many landlords who could not afford to pay their mortgages when property taxes became too high. In states like Florida, high property taxes helped trigger the housing collapse after thousands of landlords lost their ability to earn a positive cash flow on their rental houses. Rental homes located in cities can be subject to both city and county property taxes. Those tax rates can cost as much as two or even three months rent.
3. Keeping property maintained: Keeping a rental property in good working condition is an important part of being able to manage a successful investment. Even if a tenant does pay on time, the amount of wear and tear that they subject a property to can cost the landlord thousands of dollars. This is why number 1 is so important. Good tenants won’t do much damage. Bad tenants can cause thousands of dollars in property repairs.
4. Keeping mortgage costs as low as possible: Is a big key to helping manage the costs of owning rental property. And you might think this would be obvious, but one of the most common mistakes I’ve seen over the years is a newbie landlord failing to make sure that the rental income would be high enough to pay the mortgage, taxes, insurance and maintenance.
In recent years it has been even more difficult to raise rental rates since the 2008 meltdown. With unemployment at record levels, and average yearly income falling, many landlords admit that they have had to reduce their rent rates to find or keep good tenants. I’ve experienced this myself. We’ve elected to appeal tax assessments and look more closely at other costs to help insure that we continue to earn a positive cash flow on our properties.
For all of it’s challenges, earning passive income while owning an asset that someone else is paying for is still one of the best ways for a “peasant” to move from the “lower class” to the “middle class”. And if you are really good at it, you still have a genuine opportunity to become wealthy and move into the “upper class”.
Donna S. Robinson is a real estate investor, author, speaker and investing coach in Atlanta, GA. Follow her on twitter at donnaconsults, and read her blog at www.RealtyBizConsulting.com