So you’re thinking of investing in real estate? If you’re looking for a quick and easy way to make a profit on an investment, you should find something else to invest in. Real estate investment is time-consuming. And, like with most investments, you never know what’s going to happen.
The good new is: real estate can be a good investment. You just have to be deliberate about every move you make and think long-term.
Be In It For the Long-Haul
Long-term ownership is the key to making a profit on your investment. If you buy an okay enough property in an okay enough neighborhood, chances are the value of the home is going to go up over time. Especially if you don’t let it fall to ruin.
Avoid houses that need too much work, even if HGTV tells you that it can be done. When you’re doing a dramatic remodel on a house you never know what you’re going to find. Imagine finding bad wiring or asbestos. They both mean spending money and spending money ≠ making a profit.
Know Exactly How Much You’re Spending
While spending money is inherent in an investment, you need to think a lot on what you’re spending money on in a home. You should also come up with ways to save money in the home-buying process. Every penny saved when buying a home is a penny towards you making a profit. Which, we know, is the ultimate goal.
If you use a flat-rate real estate company like TRELORA you can easily save thousands of dollars when buying a home. We only charge $2,500, so everything above that that the seller pays, we’ll give back to you. The average Denver home buyer saves over $10,000 when purchasing a home with us.
Follow The One Percent Rule
The 1% Rule is a simple way to think about whether or not a house would be a good investment. All you need to do is multiply 1% by the selling price of the home to determine monthly rent. If your monthly mortgage is more than the estimated rent, then it’s probably a bad investment.
Let’s say that you could purchase a potential rental property for $350,000. The formula would go like this:
$350,000 x .01 = $3,500 in monthly rent
You would want your monthly mortgage payment to be less than $3,500 a month, or you would lose money on the investment.
Think Beyond One Percent
The 1% Rule only accounts for the gross income of the property. But there’s more than just that in a rental. If you’re serious about investing, you also need to consider the monthly net income from the home.
Remember that you’re going to have to put money into your rental home to keep it updated. Be sure to account for that when thinking about your monthly rental price. If you’re renting it out for the same price as your monthly mortgage then you’ll actually be losing money on the home. Yikes.
You should estimate that 40% to 50% of the rent will go towards maintaining the house and paying for property taxes. In real estate, this is commonly called the 50% rule. Let’s say that you’re charging $3,500 for rent. We’ll estimate 50% is getting put towards expenses.
$3,500 in monthly rent x .5 = $1,750 towards monthly expenses
This leaves you with $1,750 to cover the mortgage payment and make a profit. Think ahead when you’re investing and make sure that your mortgage payment is low enough for you to still make a profit. You can always up the rent price. But don’t go too high or you’ll be out a renter and out of money.
Know How Long Will It Take For the Property To Pay For Itself
The Gross Rent Multiplier (GRM) is the ratio of the price of the real estate investment to the annual rental income. Unfortunately, this doesn’t include the costs of all of the expenses, like that $1,750 each month from earlier that’s going towards expenses on the home. But the result of the equation? The estimated amount of time it’ll take for the property to pay for itself. Let’s say that you purchased a home for $350,000. After charging $3,500 for rent each month, your annual gross income from the property will be $42,000. Here is what we find if we put it in to the equation:
$350,000 for the home ÷ $42,000 gross annual rental income = 8.33 GRM
In this scenario, it will take you a little over 8 years to pay off the property using the gross rent.
You should use GRM to screen properties. Avoid fully relying on it because it doesn’t account for a lot of pretty vital things, like expenses and interest. But generally speaking, the lower the GRM, the faster you’ll make back your investment. Avoid houses with extremely long GRM’s, because you’ll likely need to make big investments in them (like a new roof), before the house is paid off. And that could really hurt your wallet.
Don’t Just Buy To Buy
It’s easy to get caught up in the excitement of finally having a rental house. And your standards for it might not be as high as the standards for your home. You’re not going to be the one living there and renters might not take great care of it. But don’t just buy to buy.
And, sure, you’re probably going to have to put a little bit of work into the home. But avoid buying a home that you can’t easily spruce up yourself. If the home is a true fixer-upper and you’ve never used a hammer before, well, it’s probably not the home for you.
Look for homes in areas of low crime that have good school districts. With the right combo of attributes you’ll have low vacancy rates.
Do Your Homework
Speaking of schools, be sure to do your homework when thinking about investing in real estate. Read more than just this article, talk to people who have invested in properties before, and have a long-term real estate investing plan. With the right amount of foresight, we know you do a great job investing in rental properties.
Brady Miller, CFA is Chief Executive Officer at Trelora, Inc. Brady joined Trelora in August, 2018 as Chief Financial Officer. He moved into his current role later that year and is responsible for all daily operations and growth of the broader real estate business. Prior to joining Trelora, Brady was Chief Financial Officer of Leeds West Groups which is one of the largest, and fastest growing automotive retailers in America. Brady managed their real estate portfolio, financing, human resources, and accounting. He earned a Charted from the CFA Institute in 2016 and holds a bachelor’s degree from the University of Colorado, Boulder where he majored in Finance and Real Estate.