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Let me first start out by saying that our first rental house did not start out with the intent of being a rental. It was actually a home I had purchased before I married my husband- he already had a home purchased as well. So, once we got married, we decided that instead of selling my home I had only had for a year we would rent it out. After that, I began diving headfirst into the world of real estate investing and began to realize our first rental property may not be that good of an investment. Here’s why….
The property does not pass the one percent rule.
The one percent rule says that when you purchase a rental property, you should be able to rent the house for at least 1% of the total house price. This general rule helps you factor in quickly cost of mortgage, maintenance, etc.
Example
When you find a house you are interested in, research what average rent is for houses similar to yours in the same neighborhood. If the average rent is $1,500 then you should not pay more than $150,000 for the property.
Our rental property
When I purchased my then home, now our rental property, I paid $270,000 for it. Today, we are getting $2,100 for the property. When I purchased the home, I was not using my investor brain that uses data to determine if I should buy the property- I was using the emotional side of my brain that says I love this house and I think it is a good deal for me to live in.
Takeaway: When purchasing a rental home- let the financial data speak to you. That is how you will determine if the rental property is a good investment.
I got a 15-year loan on the property.
This idea took me awhile to get over. A 15-year loan is smart, right? Yes, it is, if you don’t think you will get a better return on that extra money you are putting towards your property. My husband and I both got 15-year loans on our homes to avoid the additional interest of the life of the loan- normally, I would say this is decently sound advice if you can afford it. However, you have to ask yourself “what could I be doing with that extra money instead?” For real estate investors, it’s going towards your next investment in the hopes that you will beat out that ~4-5% interest loan.
Example
Greg is going to purchase a $150,000 property and is trying to decide whether he should get a 15-year or 30-year loan. If he goes with the 30-year loan ay 3.8% interest, his payments will be about $700 per month and he will pay $100,000 in interest over the 30-year life of the loan. If he goes with the 15-year loan at 3.2% interest, his payments will be about $1,050 per month and he will pay $40,000 over the 15-year life loan.
Wow! He is automatically saving $60,000. Seems like a great deal, right? Well, if you consider the fact that he will save $60,000 over 15 years- which equates to an extra $4,000 a year- you have to ask yourself “could I have gotten a better return with the extra $350 payment every month.” Real estate rental properties typically have a return of 6-10%, which far outweighs most mortgage interest rates. Before you commit, run the numbers and see what works for you.
We hired a rental management company to manage the property.
This does not apply to everyone. Rental properties can be a great resource depending on how real estate investing fits into your life. Because this was our first rental property and we had done zero research into real estate investing, we decided to hire a rental management company. Because we had no idea what we were doing and didn’t want to run into any legal trouble from lack of knowledge, we decided it was best for us to hire professionals. Realistically, this was a good move for us initially. However, now that we have more knowledge on the topic, it pains us to have 10% of our rent disappear every month for something we could manage ourselves at this point.
Our rental property
Our rental property currently rents for $2,100 per month. The rental property management company we use, charged us our first month’s rent and 10% of the rent every month. Over the current 2-year lease on the property, that is almost $7,000 over two years- or $290 per month that we could have in our pockets going towards more real estate investments.
As I mentioned, rental management companies can be a great resource and for many situations it can be the best option. Weigh out the time you have available along with what you could make if you weren’t managing your rental property and do what makes the most sense for your situation.
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