I began investing in single family homes with a good friend and business partner about 4 years ago. In that time, we’ve purchases and remodeled 5 single family homes, all of which are rented by reasonably reliable tenants. Over that time we’ve learned a thing or two about investing in real estate. In this article, I’d like to share with you what we’ve learned.
Photo by sleepyneko via Flickr
1. Know the Neighborhood
We invest in properties located in the hometown where we grew up. Most of the properties are just minutes from the home I grew up in and where my mom still lives. We know the neighborhoods and school districts very well. This makes valuing the properties and rent extremely accurate, which is critical. Some successful real estate investors invest in areas they know nothing about, but it adds significant risk to your investments.
2. Find Professionals that Know What They are Doing
I’m fortunate in that my friend has invested in real estate for years and his father has been a realtor and investor for more than 30 years. When the three of us drive through a neighborhood, I hear things like, “I’ve sold that home 2 times” or “that home had major fire damage 10 years ago.” The point is, seek out and find professionals that know what they are doing.
3. Use Rents to Drive Value
Unless you plan to flip the home, use expected rents to determine the value of the home. As a rule of thumb, we look for homes whose expected monthly rent is 1% of our total cost (including rehab expenses). If we have $100,000 into a home, we want rents of $1,000. This works nicely where we invest (mid-west), but will not work everywhere. If you invest on either coast, for example, rent to value ratio will typically be much less. Regardless, focus on expected rents, because that is what drives cash flow.
4. Seek Long Term Tenants
Vacancy and turn over are what will kill a real estate investment faster than anything. When one tenant moves out, you not only lose rent while you’re looking for a new tenant, but you inevitably spend money touching up the property. For this reason, we look to lock in a tenant for 2 or 3 years. It was a surprise to me, but tenants of single family homes are generally willing to agree to long term leases.
5. Start Slow
It was pretty exciting when we bought our first rental property. Actually, we bought two at the same time. Both were HUD foreclosures. And I was scared to death. Taking on two additional mortgages for two properties that required renovation and the prospect of finding good tenants was overwhelming. For this reason, start slow. There is always time to ramp up once you know what you are doing.
6. Just Say ‘No’
Don’t fall in love with a property or a deal. No matter how good a deal you think something is, another one is just around the corner. We thought the first four properties were great deals, but the fifth one was far better. And who knows, #6 could be even better.
7. Find a Portfolio Lender
Most mortgages are sold soon after the transaction closes. Freddie and Fannie buy a lot of mortgages, for example, and the mortgages they buy must meet certain very strict and unforgiving standards. A portfolio lender, on the other hand, keeps the loans in their portfolio. The result is you can find terms that are more favorable than a traditional mortgage.
For example, we are able to borrower 100% of the post-renovation value of the home on a 20-year note with a variable rate that resets just once every five years. Not a bad deal for an investment property. Most portfolio lenders are small local and regional banks. To find one, ask a real estate agent or investor.
8. Maintain Your Properties
You will get maintenance calls, the roof will go bad, and siding will fall off the house. That’s the reality of real estate investing. The key is to stay on top of repairs. It keeps tenants off your back and the home in good condition.
9. Don’t Negotiate with Late Paying Tenants
This one was tough for me to learn. When a tenant calls to explain why the rent is late, don’t cut them slack. If they leave a voice message, we typically don’t return the call. This sounds cold-hearted at first, but imagine how the bank would respond if you called to say the mortgage would be late. The point here is not to be mean to tenants, but the best response is to initiate eviction proceedings on a set schedule. For us, we have a late fee that kicks in after 5 days and we typically start eviction proceedings around day 15. This can change depending on our schedules, but you get the idea.
And by the way, we have yet to evict a tenant! So far, all late paying tenants have paid once they get the eviction notice. This is related to point #8 above. We keep our properties in excellent condition. Having held up our part of the bargain, it’s reasonable to expect the tenants to keep their end of the deal.
10. Keep Your Own Finances in Good Order
This is absolutely critical. So many real estate investors live life on the edge, fully leverged in their investments and personal finances. It’s the wrong approach. My business partner and I could pay the mortgages if all five of our homes were vacant. It wouldn’t be easy, but we could do it. If your personal finances aren’t in good shape, you’ll find yourself cutting corners and making bad investment decisions as a result.