INVESTING IN RENTAL PROPERTY TAKES MORE TACT AND FORESIGHT THAN IT DID JUST A COUPLE YEARS AGO
Yes…investing in real estate is the single best way to create generational wealth. It is a long term strategy that is tried and true and has been the anchor of the American economy arguably since at least 1620. But that doesn’t mean it’s easy. And it certainly doesn’t mean you can just toss your money down, like you might in an index fund, and expect the rest to take care of itself. While that index fund will ebb and flow unpredictably but always trend toward a 7-10% return, real estate investments almost always flatline out of the gates, and you might even find yourself underwater. In other words, there’s an inherent sacrifice and learning curve for the first year or two and you’re not going to stand up on a wave just because you bought a surfboard. There are specific obstacles, some obvious, and some hidden by the tide, that you need to be cognizant of and have a plan for. But once you’ve got it, you’ve got it. And there’s no better investment strategy than one that is highly repeatable and rooted in passive income paid for by others.
THE IDEAL SCENARIO: A.K.A. 2015-2019
Not all that long ago, real estate investors were looking at a price of roughly $50,000 per unit. So a four unit apartment building would cost about $200,000. At the same time, lenders were asking for 20% down. This was a highly affordable time to invest. For just $40,000 down, you could purchase a property and the remaining $160,000 plus interest would ultimately be paid for by the rents from your tenants. This was the norm. Discounting other expenses, and obviously there are other expenses, you’re looking at a 400% return on investment over 25 years!
But that was obviously not a normal time and those figures no longer apply. Interest rates were historically low and the housing market was in full rebound after the Great Recession. Using these numbers to inform your current investment is a mistake and fully worth mentioning because the best case scenario is often sticky (and therefore dangerous) for the inexperienced investor.
LEARN MORE: THE TRUE COST AND VALUE OF REAL ESTATE INVESTMENT
5 REASONS WHY BUYING A RENTAL PROPERTY DOESN’T MEAN YOU’LL NECESSARILY MAKE MONEY
1. PURCHASE PRICE
It now costs over $100,000 per unit if you’re looking to buy a rental property. So that same apartment that would have cost you $200,000 five years ago has doubled in price since. On top of that interest rates are up and lenders now require a downpayment of between 25 and 30%. The $40,000 you saved up to buy this property isn’t even close to getting you in the door. Using the conservative estimates of 100K/unit and just 25% down, you need $100,000 just to purchase this investment property.
Maybe you’ve got that 100K so you’re not sweating it, but you now have a loan out for $300,000 compared to the $160,000 you were looking at covering had you bought before the pandemic. The good news is: rents are up. The bad news: you’re gonna need every penny to cover your mortgage, taxes, insurance, and utilities. Is the game still winnable? Absolutely…but your margins are much tighter, especially early. And we haven’t even talked about vacancies, evictions, and turnover costs.
LEARN MORE: RENTS HAVE SKYROCKETED: HOW IS THIS TIED TO MORTGAGE PAYMENTS?
2. MAINTENANCE
Maintenance is the most significant hardship for investors. It’s a variable cost that is a reality and unavoidable, but it's still the area where property owners have the most complaints. As humans, we are all programmed to be loss averse, and maintenance costs seemingly pluck that string time and time again for inexperienced (and even experienced) real estate investors. But maintenance needs are unbiased and inevitable. Be it an issue with a roof, a pesky water leak, mold, lead paint, or a heating related issue, sooner or later something is going to happen and it’s going to eat into your bottom line. Whether it’s a series of small issues that accumulate, one major and costly issue, or a combination of both, you need to mentally prepare for this reality and budget appropriately. The theme here is the same…your margins continue to get tighter and tighter, especially in the first years of ownership. The good news is that over time, maintenance costs slow down because your responses have helped improve the overall quality of the structure.
LEARN MORE: MAINTENANCE COSTS ALWAYS FEEL LIKE A LOSS, BUT THEY SHOULDN’T
3. THE MARKET
The market matters, but not as much as purchase price and maintenance. To return to a previous analogy, the market is like the tide. It’s going to move cyclically and at times it can cover and absorb obstacles and at others it can decrease your options by exposing rocks and limiting the paths available to you. If you invested when home prices were low, time alone led to the creation of equity in your property. If you bought during the recent spike in prices, it’s likely that receding tide is going to be a nuisance.
The opportunity for quick equity is just not there right now. There is limited room to add or take advantage of quickly accruing value because the market is stagnating due to increased interest rates. As those rates have increased, purchasing power for potential buyers has decreased so naturally home prices will be coming down to meet those buyers…eventually. So either you can wait it out or you can buy something turnkey, with minimal maintenance needs and high rents, with good quality tenants. This is the best play at this time, but it’s predictably going to cost a bit more up front.
LEARN MORE: DOES IT MAKE SENSE TO KEEP RENTS BELOW MARKET?
4. YOUR MIND/ YOUR ATTITUDE
It’s important for real estate investors to remember that they are running a business first and foremost. Sure it’s a service and you’re providing an essential commodity for people, but your financial objectives need to come first if your goal is long term success. You need to respect and value your tenants but you can’t let empathy and emotions interfere with your financial obligations. When it comes down to it, and often it does due to the nature of housing, all people are looking out for their own priorities first. Which means discomfort is certain and you need to be able to withstand dealing with people when they’re in survival mode. When others are at their worst, you need to be at your best, and that means checking your ego. Being right and winning an argument might feel good…but it can be, and often is, costly when you stray from your financial objectives.
LEARN MORE: UNDERSTANDING YOUR RELATIONSHIP WITH YOUR TENANTS: TENANTS ARE BOTH YOUR CUSTOMER AND YOUR BOSS
5. OUTSIDE INFLUENCES
Family and friends have nothing to lose by telling you their opinions and they’re always happy to come off as intelligent with the double incentive of being helpful. Nine times out of ten you should nod, smile, and toss their advice in your back pocket. The world is full of noise and you will not succeed in real estate investment if you rely on anecdotal opinions or social media trends. If you (or your Uncle Ted) read it on Facebook, it’s not out there to help you get ahead, it’s out there as clickbait to make someone else money. As was mentioned under item 4, everyone has their own priorities…don’t cling to what you’ve seen or heard without diving in and seeking expert opinions.
LEARN MORE: DON’T MAKE THE MISTAKE OF RENTING TO FRIENDS OR FAMILY MEMBERS
A SMART SOLUTION
Real estate investment is most successful when you’re able to grow your portfolio over time. It takes patience and a full understanding of your local market and market trends. Like most endeavors, the best way to do it right is to build a relationship with someone who has done it successfully time and time again. Nexus Property Management® has managed thousands of residential and commercial units in Southern New England. Our size and experience allows us to add efficiencies and price savings that single landlords just cannot provide on their own. This allows us to find space in those margins that would otherwise be razor thin for property owners who tackle this market on their own.
Hiring a property manager is the best way to ensure your rental property makes you money. Contact any of our offices to learn more.
LEARN MORE: WHEN HIRING A PROPERTY MANAGER, MAKE SURE THEIR INCENTIVES ALIGN WITH YOURS
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Mick Lefort is the Vice President of Operations for Nexus Property Management®. A National Property Management Franchise that manages all types of rental property from single family homes or condos to large apartment buildings and complexes.
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