Since you most likely don’t want to live in a dumpster, (especially during the winter) you’ll most likely exchange money for a place to live. I know, this is a brand new concept to most of you. Or, if you want to get really fancy, you’ll buy a place to rent out to other people.
But how do you decide what property to buy? Do you just print out feature sheets of all the properties, blindfold yourself, and let a dart decide which place you’ll call home? Nah, that’s a sucker’s game. Here’s how to invest in property the right way.
First of all, you’ve got to figure out what your return on investment is. Figuring out your potential rent is a straightforward affair, all you need to do is look at comparable properties on Craigslist or your local paper and see what they’re renting for. The only potential downfall is overvaluing your property for reasons that only make sense in your head. Ask your realtor or a friend for a second opinion. A good rule of thumb is your monthly rent should be more than 1% of the purchase price of your place.
Next we’ll look at expenses. This is pretty simple, once you’ve factored everything that can possibly happen. Depending on the property you buy, you’re looking at condo fees, insurance, property taxes, maintenance and repairs, vacancy, and any fees a property manager might charge. Many potential landlords underestimate a renter’s ability to be hard on a property, so they’ll often assume less costs for repairs and vacancy. As a quick rule of thumb, I use 25% of gross rental income to be lost to regular expenses. Some years you’ll have more and some years less, but I’ve found the average works out to about that number.
This is all fine and good you say, but how about the good stuff. You promised the right way, which implies some deep dark secrets or something. Okay, fine. Here are mistakes I see landlords make all the time.
1. Assuming the market always goes up
Unlike the U.S., Canada’s real estate weathered the storm of the great recession. This is obviously good news for real estate investors, who cheer from the sidelines as their property becomes more valuable. But as investors have watched the market grow, they’ve accepted terrible cash flows because they’re just assuming property values will go up forever.
My rule of thumb is very simple. I assume a property will never increase in value. This accomplishes one major thing, and that’s discipline. Real estate can be a risky investment, and that’s my built in margin of safety. Rather than thinking of capital gains as something that happens every year like clockwork, view them as a nice bonus that you might get in the future.
In the meantime, just buy properties that easily pass the 1% rule from earlier. And if you can’t find any properties that fit the criteria, then maybe it’s time to move your money to a different asset class.
2. Renovations with no return
The second biggest mistakes small landlords make is they spend too much money fixing up a place that a renter is just going to trash anyway. Finding a renter who treats your place as nicely as you do is next to impossible.
Before you do that kitchen renovation, actually crunch the numbers. If it’s going to cost $10,000 and you can only get an additional $50 a month in rent, it’s probably not something you should spend money on.
Big landlords get this, and they know how to really maximize their investment when they spend on improvements. Painting is inexpensive (provided you do it yourself, and you can), and gives a place a nice new look. Rather than redoing the whole kitchen, a savvy landlord might just replace the flooring or the countertops. It’s easy to renovate a place so it’s up to your standards, but just remember that owning rental property is a business, and that business should be motivated by the bottom line.
You’ve heard the same advice about buying the worst house in the best neighborhood a million times now, so it must be true. I guess it is, but there’s a better way. You might not like it, but remember, this isn’t a vanity contest.
All you have to do is buy a property in a neighborhood that’s a little more fringy. Why would I recommend that? There are two reasons.
Like every market, real estate is driven by supply and demand. If more people want to invest in the nice part of town, that’ll depress prices across town. Depressed values usually mean greater cash flow for the investor, along with capital gains if the market goes up. Also, more people rent in the poorer parts of town, increasing your pool of potential renters. Your rental property may look like a crack shack, but do you care if it’s churning out a nice return?
Investing in property is hard. You have to deal with dirtbag tenants, constant repairs, paying a mortgage, along with a million other things. Hopefully these tips can help you profit on your next rental.