Mike McMullen is the CEO of Prominence Homes and the author of Build. Rent. Sell. Repeat!
Every athlete knows the importance of the fundamentals. From how runners hold their arms to where quarterbacks grip the football, professionals are often the first to tout the importance of mastering fundamental skills.
A focus on the fundamentals is important in virtually every arena of life, and investing in rental property is no different. The endgame of rental property investment is rewarding: passive income, excellent tax benefits and a road to significant wealth.
But to arrive at the summit, you must first learn the fundamentals. I can’t claim to be a professional athlete, but I can claim to be someone who has made a successful career constructing, managing and selling rental properties.
I know the fundamentals of investing in rental property from 20 years of experience. Here are some of the fundamentals I picked up along the way.
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To make a good return on investment (ROI) in the rental investment world, you’ve got to learn to maximize leverage. This means using debt to make money (i.e., generating cash flow with mortgages). Buying with a mortgage removes the enormous barrier of entry that is “buying a property outright,” but it also allows you to buy more property, multiplying your income and feeding your cash flow.
I wish I could say I made this up. I didn’t. Robert Kiyosaki, author of Rich Dad Poor Dad, has a great explanatory article on the topic, specifically on the difference between “good debt” and “bad debt.” Read up on it if you want to learn more.
Maximizing leverage will take some time, effort and attention to detail. If that sounds tedious, just remember that you are investing, and investing is work! Your long-term goal is to construct a portfolio capable of generating passive income. But in the short term, view investing as a job.
The obvious route to making money from your rental property is renting to tenants, but rent is just one potential revenue stream among many. The goal is to minimize cost and maximize profit, and to do that, you’ll definitely want to educate yourself on the basics of property appreciation.
Assuming that you purchase property in an up-and-coming area, your real estate is likely to increase in value over time. This can provide you with an extra return on investment over the course of five to 10 years.
While you may tend to think of rental investment as a way of guaranteeing passive income, it can also be a viable long-term investment strategy if you purchase property and sell at the right time. Be patient, buy well and keep your eye on the market.
Deduct, Reduce And Minimize
Make the most of those tax deductions to improve net profit. Always keep an eye out for what you can deduct. Remember that in this area, a dollar deducted is a dollar earned.
More importantly, reduce the property tax that you are required to pay by buying in low-property tax states. I know too many people who get into the rental property world with their eye on fancy coastal property in states like California or Florida, but often, “bread-and-butter” rental housing in places like Alabama, Colorado or Utah is the way to make excellent returns. This may seem restrictive, but as an investor, you’ve got to be flexible about what you want.
Finally, you can minimize maintenance costs by buying build-to-rent property. Property built expressly for rent will include homeowner warranties as well as newer appliances and utilities. This means less maintenance, which means less work for you, and less expense.
Take Calculable Risks
Property investment (like all investments) is inherently risky. This is why a lot of folks steer clear of it, preferring to grow their wealth by avoiding risk altogether, quietly cutting expenses and stowing money away for later.
Others prefer to take small risks: putting a portion of their assets into investment and saving the rest.
But big risks and small risks amount to the same thing: risk. Rather than focusing on how big a risk you are taking, I’d recommend seeing things in terms of what is calculable and what is unknown. You should be willing to take some big risks with your investments, but only the kinds that are calculable.
Allow me to use an analogy: imagine I offered you $1,000 to swim across a river. Would you do it? A coward would likely turn down the offer outright, letting fear dictate their actions. A fool would agree to anything, following their greed to a miserable arrival on the far bank. But the clever investor would do well to ask some follow-up questions. How wide is the river? Is the water cold? Are the fish dangerous? Will I move through sharp rocks? Is the water frequented by tug boats and trawlers?
Asking questions such as these is one form of risk analysis.
You may never be able to fully calculate systemic risks (risks that depend on changes in the environment, law or economy), but you can, with enough time and experience, learn to tabulate your operational risks (risks that depend on your business model and finances).
Learn to control what you can, then take risks within that framework. This might mean leveraging a loan for a run of properties or refinancing to pay a mortgage sooner. However scary it might look, don’t shy away from risk. Account for it!
Play The Long Game
Finally, make sure you see rental property investment for what it is: a long game. Like all investments, it’s not some get-rich-quick scheme or infinite cash cow. People who see it that way will likely find themselves disappointed with the results.
Instead, think of your rental property as a way to generate passive income and, as such, something that requires you to play the long game of frequent, flexible investment. Keep your nose to the grindstone, focus on the fundamentals and you’ll generate that ROI you are looking for.