When asked what’s one of the best ways to diversify a real estate portfolio, chances are a seasoned real estate investor’s answer will be to invest in long-term rentals (implement a buy-and-hold strategy). Rental property investment can be a great source of income that appreciates over time.
According to data from the Census Bureau, there are about 48.2 million rental units in the United States (DeSilver, 2021). Individual investors own about a third of those units, including many single-family and duplex rentals.
As a new REI, you may be overwhelmed by getting started in rental real estate investing. But, implementing a buy-and-hold strategy could be one of the best investments, provided you do your due diligence before getting started.
Read on to learn more about this exciting investment strategy.
Buy and Hold Vs. Fix and Flip
Two popular real estate investment strategies are fix-and-flip and rental property investment, also called a buy-and-hold strategy. Both generate income for REIs, just in different ways. A fix-and-flip strategy typically produces profits in the short term, while a rental strategy creates predictable passive income for the long term.
Choosing your rental investment property location
Buying a rental property sounds straightforward, but doing so correctly—and getting a good deal on something you will want to own for the foreseeable future—is a bit more of a challenge. This is especially true if you’re embarking on a buy-and-hold strategy and want to learn how to buy your first rental property without making common mistakes real estate investors can often make.
Beginners should talk to an experienced real estate agent who knows a particular rental market well. An agent can offer insight into the local rental market, where it could be headed, how rent prices are trending, and more. These helpful insights can be valuable in deciding where to purchase a rental property.
When deciding on the geographic location for your rentals, you should consider the following:
- The price range of homes
- Rent price ranges
- Rent/cost ratio
- Rental demand
- Occupancy and vacancy rates
- Quality of area
- Quality of school district
- Crime level
- Distance from your own residence
Looking at how rental activity for an area was affected by economic downturns can also give you an idea of how well you’re likely to fare if something similar happens again. It’s also good to look at broader economic trends and how that might affect a particular rental market. For instance, a growing population and a strong job market are indicators that rental demand is more likely to remain steady.
Types of rental properties
Below are three common ways to add rental properties to your investment portfolio:
- Long-term rentals are typically rented out to tenants for one year or longer. Different types of property fall under this umbrella — single-family houses, townhomes, duplexes, apartments and condos.
- Short-term rentals are rented for a few days, weeks or months at a time. Suppose you purchase a home in a popular vacation area like Orlando, FL. You could rent the house through platforms like VRBO or Airbnb to different tourists weekly.
- Turnkey rentals already have everything in place to generate rental income in the long term. An example of a turnkey rental is purchasing a property that already has tenants in place.
How you can make money on rental properties
There are several ways in which rental properties generate income for a real estate investor. Let’s take a look at a few:
- Cash flow is the difference between the money you make from rent payments and what you pay to cover operating expenses. Suppose your rental property incurs $750 a month in expenses and generates $2,000 a month in rent. The net cash flow would equal $1,250.
- Appreciation is the rise in an investment property’s future value over time (Dehan, 2022). Simply put, you buy a rental property and hold on to it as long as you can—thus the name, buy-and-hold—and then sell it for more money than you spent purchasing it.
- Passive income is income generated with little to no effort, and it’s one of the best ways to build wealth and financial independence over time (Constable, 2022). Rental property investment can fall under this category—it generates recurring income, and you can outsource the day-to-day management to a property manager.
- Tax benefits from key tax deductions. Depreciation, repair and maintenance costs related to your property can be deducted from taxable income. Speak to your tax advisor before getting started.
Hiring a property manager
Being a landlord can be a very demanding job! As mentioned, you aren’t achieving passive income if you’re constantly at work, managing the day-to-day operations of your rental properties. That’s why many rental property investors hire a property manager—to save time by outsourcing tasks.
Below are some everyday tasks of a property manager (Richardson, 2022):
- Marketing of empty units
- Capturing and following up with leads
- Creating, sending, and reviewing rental applications
- Screening prospective tenants
- Creating, sending, and reviewing your lease agreement
- Tracking expenses
- Responding to maintenance requests
- Communicating with tenants
- Collecting rent
You will pay a fee to the property manager for their services, somewhere between 8% – 12% of the monthly rent collected (Rohde, 2022). But it may be worth it if your rental property income becomes more passive. Consider how adding a property manager’s fee to your monthly operating expenses may affect your rental investment cash flow.
The bottom line
Owning rental properties is a sound investment choice that has the potential to bring you to a place of financial freedom through rental income, appreciation, and profits.
It will take time to earn a steady profit and achieve your financial goals. If you do everything right, however, you could get to the point where you can leave your day job because you’re earning enough passive income from your properties alone. But, you must first understand the basics.
If you’re new to rental investing, work with an experienced real estate agent, a trustworthy lending partner and a good property management company to help ensure things run smoothly.
References
Constable, K. (2022, December 16). The 6 categories of passive income, explained. Time. Retrieved January 27, 2023, from https://time.com/nextadvisor/financial-independence/what-is-passive-income/
Dehan, A. (2022, August 29). What does appreciation mean in real estate? Quicken Loans. Retrieved January 27, 2023, from https://www.quickenloans.com/learn/appreciation
DeSilver, D. (2021, August 3). As national eviction ban expires, a look at who rents and who owns in the U.S. Pew Research Center. Retrieved January 27, 2023, from https://www.pewresearch.org/fact-tank/2021/08/02/as-national-eviction-ban-expires-a-look-at-who-rents-and-who-owns-in-the-u-s/
Richardson, S. (2022, November 23). What does a property manager do? What Does A Property Manager Do? | Rocket Mortgage. Retrieved January 27, 2023, from https://www.rocketmortgage.com/learn/what-does-a-property-manager-do
Rohde, J. (2022, June 7). How much do property managers charge? here’s a breakdown. Stessa. Retrieved January 27, 2023, from https://www.stessa.com/blog/how-much-do-property-managers-charge/
