I see a lot of new/prospective landlords and established investors in my area of expertise, San Antonio property management. Lessons from someone who’s been in the business for well over thirty years, take it for what it’s worth…
- The easiest way to get started as a landlord/investor, by far, is to make your first home purchase be an investment home, such as a single-family residence. There are thousands of books and guides on the details, and your first purchase is usually the easiest one to get favorable financing.
- For this reason, a lot of new landlords are starting with inexpensive rental units. Which is fine, in fact, it might be the best way for people with little cash to get on a path to being a member of the investor class.
The 2% rule explained.
The 2% rule is used to determine if long-term rental properties are a good investment by using a very simple equation. If monthly rents are equal too, or greater than 2% of the purchase price on a rental property, than the rental property is considered a good buy. To make it really simple, if you buy a 100k house it should rent for $2,000 a month. Most San Antonio rental properties don’t come close to meeting this rule but do however make great investment properties if bought right. Most of my clients are extremely patient and usually buy their properties at least 20% below market, with rent to purchase price ratio of 1.3% ($1,300 rent on $100,000).
- Many professionals explain the 2% rule is great for beginners because it is simple and keeps them out of trouble. I think it may cause more problems than it prevents because it is actually too simple. There are too many variables that go into evaluating a rental property for a beginner to only consider rent versus purchase price.
- Seasoned investors can look at a house and determine if it is a good fit almost immediately because evaluating deals has become second nature. Beginning investors, need to be looking at all the details; rent, expenses, repairs, mortgage, location, etc. They need to thoroughly analyze exactly what the returns will be based on certain estimates. Not only does running all the numbers help a beginner figure the returns, but it also helps them learn the process of evaluating properties. There is no secret calculator that can evaluate every potential rental property; each property needs to be analyzed based on the most important variables.
There are important and ongoing fixed costs per unit that don’t balance with purchase-price or rental income.
- It costs a certain amount of money per year to own a water heater, or a roof, HVAC system or a garage door opener, etc., those things break and wear out and need to be maintained or replaced.
- Maybe the high-end property has nicer appliances and fixtures, but it doesn’t cost anything close to 6x as much to own a stainless fridge as the cheap one (in fact, the better stuff may have a comparable or even lower total cost of ownership, especially if you have better tenants).
- The roofing company doesn’t charge less to work on a lower priced property than they charge on a high-end home, and neither does the plumber, the water-company, the landscaper, or anyone else. It costs about the same to replace a toilet or paint a unit in an affluent neighborhood as it costs in the lower income neighborhood and those are fixed cash expenses.
Alternately, on a higher end property, on an actual cash basis, you have a lot more flexibility to exercise judgment about how much you want to pocket, versus re-investing towards making or keeping your units desirable and attractive to the most stable and desirable tenants.
Last but definitely not least, is the cash-basis effect of equity growth on both scenarios. Even if you invest purely for income and not for equity, it is reasonable to assume that, long-term, rents and equity should roughly keep pace at least with inflation.
None of this is to say that buying lower priced rental properties is a bad idea.
It might be the best decision you ever make, and it’s often the only way to enter the game in the first place. And plenty of people have gotten very rich in lower-income rentals.
Just make sure, when you run your numbers, that your assumptions reflect the ownership costs of all the toilets and windows and roofs and driveways and sinks and hinges and water heaters and so on. It may be that the cheaper units are still better than the premium ones, maybe much better. But only by using realistic fixed costs will you be able to compare apples to apples.