Turn on HGTV on any given day and you’ll likely see a pair of real estate investors buying a run-down property for dirt cheap and flipping it for a profit. They make it seem so easy too. Buy it, fix it up, and sell – no red tape or paperwork required. Unfortunately, in the real world, flipping for a substantial profit is often the exception, not the rule. And, if you’ve ever endured a renovation, you know that it has to earn a pretty penny to be worth the headache. Not one for self-inflicted pain, I prefer to play the long game and invest in properties that will appreciate over time. However, even if you score the deal of the century (as seen on TV), without tenants you won’t see a profit until you sell, which in my mind, is a missed opportunity. So, if you want your investment to start working for you now, it’s time to get into the landlord game. As with most games, you need to know the statistics, have a game-winning strategy, and a knowledgeable coach to get you there. Fortunately, I’ve created quite the playbook, so suit up and let’s get to work!
Study The Statistics
One of the most important statistics to consider when purchasing an investment property is the vacancy rate in the area. The vacancy rate represents the average amount of time that a property will sit unoccupied in a year. A low vacancy rate is a great way to determine if an area is a good market for an income property as it demonstrates a high demand for rentals. Investors also use the vacancy rate to estimate the amount of revenue they can expect to lose from their unit sitting empty between tenants. Let’s assume you own a two-bedroom property in South Carolina to demonstrate how this metric helps predict lost revenue.
Currently, South Carolina has a vacancy rate of 6.6%, and two-bedroom properties rent for an average of $788/month. With a 100% occupancy rate, you’d make $9,456 in rent, annually. Now, let’s assume your property will sit vacant for 6.6% of the year as the vacancy rate suggests. This leaves you with $8,832. While $624 doesn’t sound like a big loss, a vacant property usually indicates that you’re between tenants, which can cost $1,000 – $3,000 per unit. Based on South Carolina vacancy rates, you likely won’t have to deal with turnover every year. However, even when tenants stay, you need to be prepared to pay annual maintenance fees. If you’re not sure how to estimate maintenance fees for your property, I’ve got a few trick plays (calculations) to help you get there.
Know What You’re Up Against
As I mentioned in my previous article ‘How to Quickly and Easily Compare Investment Properties’, the easiest way to compare investment properties is to determine The Net Operating Income (NOI) of each property. But, for the NOI equation to work, you need to be able to accurately estimate your fixed and variable annual expenses. Your fixed annual expenses include property taxes, waste management, insurance, and any property management/homeowner’s association fees (HOA). Your variable expenses include your annual vacancy rate and maintenance fees. These maintenance fees can include things like seasonal landscaping, appliance maintenance, and emergency repairs. Understandably, it’s more difficult to accurately predict variable expenses, which is why industry professionals use the following calculations to estimate their annual maintenance fees.
1) The 1% Rule: This rule of thumb stipulates that annual maintenance costs will equal 1% of the value of your property. So, if your property is valued at $200,000 then your annual maintenance fees would cost around $2,000.
2) Square Footage Formula: This formula estimates annual maintenance costs to equate to $1 per square foot. That means if your rental property is 15,000 sq ft., your annual maintenance fees would be approximately $15,000.
3) The 1.5X Rule: This rule uses your monthly rent to determine maintenance costs. It estimates that annual maintenance costs will equal 1.5X monthly rent. So, if your tenants are paying $1,250/month, your yearly maintenance fees would be approximately $1,875.
Once you have a handle on maintenance fees, it can be helpful to enter all your other variables in an online rental property analysis calculator to evaluate your total expenses and annual income. Just remember, that these calculations serve as estimates. It’s always best to err on the side of caution when creating your saving strategy, which leads us to our next step.
Prep for the Unexpected with a Good Defense
Unfortunately, even new builds aren’t immune to major issues, so a good rule of thumb is to create an emergency fundthat will cover three to six months’ worth of expenses (including your mortgage, insurance, and taxes). This allows you to conservatively budget for one major expense each year. Of course, this doesn’t always happen annually, but having a designated savings account for unexpected expenditures ensures you won’t be dipping into your personal savings should something go awry.
As many landlords know, even with a solid emergency fund, carrying out the repair itself can be stressful too, which is why it pays to have a good maintenance strategy in place. Lowe’s for Pros is a free service that helps investors (like you) save money, track inventory and expenses, and utilize business management tools all in one place. As a member, you’ll gain access to exclusive discounts, free shipping (on orders over $45), and save big on bulk orders, all the while tracking every single dollar spent. While an entirely stress-free repair may be an unattainable dream, this program simplifies the logistics, which makes them a VIP in my books.
When in Doubt, Bring in a Professional
Whether you have a single investment property or a large investment portfolio, you’ll be responsible for managing your property and tenants. That includes vetting tenants, ensuring rent is paid monthly, and tending to repairs, but these responsibilities don’t necessarily have to rest on your shoulders. As the property owner, you can either choose to manage it on your own or hire a property management company to do it for you.
Typically, novice investors will choose the DIY route, which I personally think is a great way to start. Although this option requires your time and energy, the hands-on experience and savings can be well worth it. The more you know about property management and common household repairs, the better you’ll be at vetting contractors in the future, saving you time and money in the long run. That said, not everyone will be in the position to be on-call 24/7, which is where property management companies come into play.
Although hiring a property management company will help turn your hands-on investment into more of a passive income stream, it does come at a cost. Most companies charge at least 10% of your monthly rent, but this can vary depending on the extent of services provided. For a relatively small percentage of monthly rent, they use an existing infrastructure to vet and manage your tenants and deal with repairs. They’re also industry experts when it comes to the ins and outs of local tenant laws, which can provide an added comfort for novice investors. Unfortunately, there are a lot of subpar property management companies out there that do little more than collect rent on your behalf. So, if you choose to hire a company, make sure you do your research first.
Deciding to invest in an income property is a huge commitment, both in terms of time and money. Ideally, the goal is for our properties to increase in value over time and provide us with a little cash flow in the meantime. While this is entirely possible, creating a solid fund appropriation strategy ensures you have an added layer of protection in case the market (or a tenant) pulls a trick play.
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