I was very grateful to turn our old primary home into a rental when we purchased a new home. It was when I discovered the monthly cash flow a rental generates and that opened my curiosity to learn more. Throughout these 16 years, I made a lot of mistakes that allowed me to master the process and system to buy/sell each property investment.
These are the 5 core steps that I follow religiously for each new purchase.
1. Know your finance
No matter what you do, I believe it is important that you know what your current financial situation and objectives are. To start in real estate investment, it is crucial that you know how much you have now and can deploy to invest in real estate. Assuming you have $50,000 set aside to invest in income property, you must also have a different allocation of money set aside as your emergency saving fund.
Besides money allocated for investment, it is also very helpful to figure out how much you need to be financially independent. I call this number the Golden number. Download this spreadsheet that I put together for you. Use it to figure out your total income, your total expenses, and the difference that you can save on a monthly or yearly basis.
As an example, it is helpful to know that your Golden number is $7500/month, meaning this is the amount you need to cover all your monthly expenses so that you will not need to trade your time for money. It is okay if your number is higher or lower. We all have different needs.
2. Pick a RIGHT market to invest
I used to live in a city with high housing prices and my 1st rental produced good monthly cash at $500/month. However, the property value was $650,000 and the rental income was $3,500/month. We had $200,000 equity in the property. Therefore, look at the return on investment calculation below:
Monthly Cash flow: $500
Equity that we have in the property: $200,000
Let calculate the return on my equity in the property:
$500 * 12 months = $6,000/year
Annual Cash on Cash return (base on the equity) = $6000/@$200,000 = 3% — good start, but there are better returns to be had.
I was very grateful to meet a veteran investor at a real estate seminar, who suggested me to look into other markets that could yield a better return. I took his advice and found a market using my $200,000 equity from one home and purchased 5 homes in another city that produced total: $1,750/month cash flow.
Let calculate the cash on cash return in this situation.
Total investment to purchase 5 rentals: $200,000 down payment + $20,000 (closing cost)
Total invested: $220,000
Yearly monthly cash flow: $1,750/month * 12 = $21,000
Annual Cash on Cash return: $21,000/$220,000 = 9.5%
You know, I’d love to invest in my hometown and I explained detailed why I would in chapter 6 of my book only when the numbers make financial sense.
80% of 100+ projects that I have acquired to date, I focused on buying income property that produces monthly cash flow from day one to build toward my financial independence. Let’s assume your Golden number is $7,500/month, then your goal is to buy at least 15-18 income producing properties which will produce $350-$450/month each. Once you have your plan down, you can achieve your financial independent sooner than you think. I did not make a plan until my first child came because I wanted more time with him so I asked myself a few questions that forced me to make a plan for my financial independence. Besides, my husband was in between jobs when my 1st son was born and he had to fly to work in a distant city. I became even more focused to create a financial independence plan for me and my family.
How can I replace my mortgage business income with real estate passive income? How can I create a secured stream of income for my family regardless whether my husband or I work or not?
A market that offers a high return on your money typically has the stable job and population growth. I explained in detail of how to invest outside of your home town in chapter 7 of my book. 99% of my income properties are out of states. In this chapter, there is a list of research that you can do in advance as part of choosing a market. You can do everything from your computer before flying to visit a city.
3. Buy Right
I typically use a two-step process to determine whether a property is worth my time to pursue further. The first of these two steps is a quick test to efficiently filter out properties. The first step is to make sure that the ‘monthly rental income to purchase price’ ratio is at least 1%. For example, if your purchase price is $150,000, then the monthly rental income should be at least $1,500, in order to meet that 1+% criteria. Monthly rental income to purchase price ratio = $1,500/$150,000 = 1%.
The second step is to calculate a ‘cash on cash return’, defined to be the annual cash flow divided by equity invested. Many investors look for a return on their money at 8-12% after all expenses pay. If the higher return is your financial goal, then you will have to be patient in the process of buying.
The return is only one factor to consider. Successful investors who focus on buying right are also looking at economic factors of the market where a property is located. Stability of such a real estate market is influenced by factors like job and population growth, a rate of increase in household formation, etc. Among other things, these factors ignite and fuel the real estate market. Properties located in a market with stronger economic foundation will prosper better than those without.
4. Finance Right
Always looks for the longest amortization term loan option available offered by a bank or a mortgage broker. You can choose 30 years fixed as the interest rate is at a historical low now. Your ultimate goal is to keep your rental for a long term to generate monthly cash flow now as you accumulate toward your Golden number. Take advantage of buying time to build your wealth by tenant pay down your mortgage balance each month and you will gain conservative appreciation base on the minimum inflation rate is average 2-3% a year. As you finance your investment, keep in mind these two objectives:
1) First, achieve and maintain positive cash flow.
2) Second, let your rental income pays down your principle. Over time, you will own the property free and clear. As you do so, you do not want to compromise your first objective: positive cash flow.
That’s why it is important to finance right!
5. Manage Right
You can manage your income property yourself as a way to learn about the business. I shared the necessary steps that you must follow to manage your rental effectively in chapter 15 of my book. If you like me, you’d prefer to focus your energy on acquiring a good project that has a strong monthly cash flow to cover for the management fee so you can free up your time to work on the other important parts of the business. 100% of my income properties portfolio is managed by the local professional property managers. I screened my property managers thoroughly before selecting them as my power team.
Repeat the process to buy your next rental.
Buying income property investments are not hard, but you must take cautious steps and feel confident making right decisions in the process. Treat your real estate investment like a business and only make the purchase when it meets your financial objectives.
Comment below on what you think.