I am trying to buy as many rental properties as possible because of the great returns they provide. I am also trying to help other investors discover the fantastic world of investing in long-term rentals through my blog. However, I run into a lot of feedback from people who are worried about how risky it is to invest in rental properties. I hear: “My friend went broke investing in real estate” or “My parents had a rental and it was a money pit up until the day they were forced to sell it.” There are many horror stories involving real estate, but I have no doubt whatsoever long-term rentals are a great investment if you do your homework and buy the homes right. Most of those horror stories come from people who did not do their homework, turned a personal residence into a rental out of necessity or were hoping for appreciation.
I am making over 20 percent cash on cash returns on my rental properties, and I tell you how to do it in my complete guide to purchasing long-term rental properties.
For more information on how to buy the best rentals which will make the most money, check out my book: Build a Rental Property Empire: The no-nonsense book on finding deals, financing the right way, and managing wisely. The book is 374 pages long, comes in paperback or as an eBook and is an Amazon best seller.
Does the money you can make off of rental properties outweigh the risk?
In another article, I talk about how much money can be made with long-term rental properties. I think most people will be very open-minded about getting into the business of buying rental properties when they realize what a great investment they are. With potential for big money, many people automatically think there must be huge risk involved. There is risk in real estate like any investment or walking down the street for that matter, but I don’t think there is much risk if you invest the correct way. If you have a long-term plan built to withstand market fluctuations, there is very little risk when investing in long-term rental properties.
Buy houses below market to reduce the risk of rental properties
One key to a low risk rental strategy or any successful real estate strategy is to buy property below market value. Buying a property below market enables you to create instant equity, increase your net worth and protects you against a downturn in the market.
Lets look at rental property number 4, the fourth rental property I purchased. I purchased the home for $109,000 in 2012, and I put about $35,000 cash into the property for repairs, down payment and other costs. My loan was about $88,000, and my break even was about $123,000 to get my full investment back out of the home. That home was worth at least $145,000 fixed up when I bought it in 2012. Since I bought the home below market, prices would have to drop 20 percent before the property would be worth less than what I had into it. Prices would have to drop even further, more than 40 percent, for the value to drop below my loan balance. Even if prices nose-dived in the next year, I would be okay because I don’t need to sell the home since this property is providing about $600 a month in cash flow.
Investing for cash flow will reduce the risk of rental properties
I consider cash flow the most important factor in my long-term rental strategy. I eventually plan to live and get rich off the cash flow from my rental properties. When I buy a property and fix it up, I expect at least $500 a month in cash flow. However, I am actually seeing higher figures and in some cases I am getting $700 a month in cash flow.
With $600 to $700 a month in cash flow, my rents range from $1,100 to $1,400 a month. For me to see negative cash flow, my rents would have to drop more than 50 percent! It is possible that house prices could fall 20 percent or even 40 percent. We saw that happen a few years ago, but rents did not drop 40 percent when the housing prices crashed. In fact many places saw only minimal drops in rental rates because rental rates are not based on the price of houses. Rents are based on the supply and demand of rental properties in any given area. If we ever see rental rates drop 50 percent, either the economy has completely crashed or a life altering event has changed a country or region forever.
The type of property you buy will reduce risk of rental properties
I base my strategy on single family rental properties that are less than 50 years old. The older the property, the better the chance of a major repair needing to be done. I have enough cash flow coming in to account for major repairs, but homes over 100 years old can have issues come up that could wipe out all equity. It is rare, but a foundation or structural problem can make a property uninhabitable and cost tens of thousands of dollars to repair. By purchasing newer properties, I lessen the chances of running into repairs that could wipe out my profit for a year or even two. Here is an article on where to find a great deal on a rental property.
How do people lose so much money investing in rental properties?
I won’t tell you it is impossible to lose money investing in long-term rentals; it is easy if you don’t have a plan or are impatient. It is not easy to buy properties below market value with great cash flow. If it were easy investing in long-term rentals, everyone would be investing in real estate.
The most common mistake investors make is buying too high with negative or little cash flow and hoping a house will appreciate or rents will go up. In this situation the investor is not really investing, they are speculating. The investor is hoping that prices will go up or the rental market will change and they will get lucky. When an investor uses this strategy, they realize it is not fun to constantly put money into a house every month. They really have no idea when the home will appreciate enough to make money, but know they are losing money now. The investor decides to sell the property and loses a lot of money because he sold in a down market or sold too quickly to realize any gains.
Don’t be scared to invest in rental properties
There are many people who have gotten rich and retired early by investing in long-term rentals. There is a lot of opportunity and many advantages to investing in real estate. Stick to the basics and make sure you have positive cash flow and you can make a lot of money without high risk.