There are numerous ways to invest in real estate. Between note buying, rehabbing, mobile home purchases and foreclosure auctions, there is something for every type of investor. One of the best ways to accumulate long-term wealth is by exploring buy and hold rental properties. The idea of having a tenant pay down your mortgage while still leaving you with cash flow is a very appealing thought. As great as it is, however, there are plenty of steps to take before you get there. One misstep during the process can leave you right back where you started. Here are the five most important steps to building a quality buy and hold portfolio:
1. Run the right numbers: Numbers are the basis for everything you do in real estate. They are especially important when dealing with buy and hold properties. If you don’t have up to date and accurate figures, everything you base your decision on will be inaccurate. Any investor can plug numbers into a spreadsheet and make the deal look appealing. Only after you get into the property and start paying expenses will you realize your mistakes. Using the correct numbers gives you your bottom line cash flow figure and will tell you whether or not the deal makes sense. Never take the seller or realtor numbers as the truth. Do your own due diligence on the property taxes, rents received, utilities, snow removal, yard maintenance and more. Numbers are the foundation of any good rental property. It is imperative you are using the correct ones.
2. Acquisition: Finding a buy and hold property where the numbers work is only the first step of the process. There is constant debate among investors as to what is more important: the initial purchase or the end sale. Both are critical, but in the case of buy and hold properties, the acquisition price is more important. Buy and hold deals, on the surface, may not appear as attractive as flip deals, but they are – I assure you.
Depending on the property, there may not be as much work needed and the list price may be higher. That doesn’t mean you can’t negotiate the best deal possible. It is important to know the seller and everything about the property. If it is has been collecting dust on the MLS, you probably have the upper hand in negotiations. If it is just listed, a lowball offer probably won’t get you the property. Although it is common sense, the lower the purchase price, the higher the monthly cash flow. The acquisition price has a direct impact on all rental numbers moving forward.
3. Financing: How you finance your rental has a direct impact on the bottom line. Most traditional lender options require 20-25 percent down payment. This may seem like a burden, but when you run the numbers you will appreciate the built in equity and increased cash flow. If this is your first property, you can take advantage of FHA lending guidelines. With FHA, you can put down as little as 3.5 percent on a two family property, live in one unit and rent the other. Most lenders will let you use 75 percent of the protected rental amount as income. Lending has gotten a bad rap over the years, but is still a viable way to finance your purchases. Additionally, you still have hard and private money options available to you.
4. Improvements: Even if you plan to rent the property out, there are times when you need to treat it like a rehab. You may not need to gut the property, but you need to make some improvements. With rental properties, quality and durability are more important than flash. All tenants like nice things, but they are usually more concerned with functionality. A hot tub on the deck may seem like a good idea, but most tenants would rather have the space. It is important to make the right improvements for the area and for the specific property.
5. Management: It is important to factor in property management, even if you don’t think you need it. By factoring this number into your bottom line, you can account for it when things change. Whether you have a dedicated property manager or not, you need to take care of the home. Even the best properties and tenants need attention. Without a property manager, you will be the point man every time something needs attention. This means you have to take time away from your job or from other projects and focus on your property. It is important to have contacts you can call when you need them. If you have to scramble around for a plumber or electrician, you will be forced to use someone you aren’t comfortable with or pay a higher price. Without good property management, you will lose good tenants and increase your chances of a vacancy.
A good rental property can change your portfolio. There will be months when you won’t get any calls on the property, and then three in the matter of one week. Such is the nature of rental properties. They take time and diligence to acquire and run, but the rewards are great.