There are many different ways to invest your money, such as
stocks, bonds, CDs, real estate, and more.
Currently, all of our investments are in index funds following the
Boglehead 3 fund portfolio. We’ve kept
our asset allocation pretty simple over the last few years. 90% of our investments are in stock index
funds (70% invested in domestic stocks and 30% invested in international stocks). 10% of our investments are in bond index
funds.
Rental property investing is something that I have always been interested
in. The wealthiest people and families I
know made their wealth not from being doctors, lawyers, or accountants, but
from real estate. Two of my favorite
bloggers, Mr. Money Mustache and Retire by 40 both have rental
properties as a part of their retirement income stream. This year, we are going to try our hand at
rental property investing as a way to diversify our investments and income
streams.
I have a few friends and colleagues who do real estate investing
on the side. One of my best friends has been
investing in real estate properties for the last few years. He is a buy-and-hold investor who owns
multiple properties and makes money on the side from rental income, property appreciation,
and tax deductions. I went to him for
help and consultation with getting started in real estate investing. He has kindly given me a lot of tips and
advice about getting into rental property investing. The other day he said to me: “Imagine if you owned 10 paid off rental
properties each providing $2,000 a month of cashflow… that’s $20,000 worth of
income each month. You’ll never need to
work a regular job with that kind of income!”
Choosing the right property
Once we had the funds necessary for a down payment, we worked with a few recommended agents to vet out potential properties. Real estate opportunities in Southern California are very limited, with high prices in the most desirable areas. While you can buy sizeable homes for under $100,000 in various parts of the U.S. such as Ohio, Georgia, Illinois, or Florida - this same amount of money may not even amount to a down payment on a much smaller home in various popular cities around Southern California. One absolute when it came to looking for a rental property was that it had to be within a reasonable driving distance of our home; we wanted to manage our own property.
Once we had the funds necessary for a down payment, we worked with a few recommended agents to vet out potential properties. Real estate opportunities in Southern California are very limited, with high prices in the most desirable areas. While you can buy sizeable homes for under $100,000 in various parts of the U.S. such as Ohio, Georgia, Illinois, or Florida - this same amount of money may not even amount to a down payment on a much smaller home in various popular cities around Southern California. One absolute when it came to looking for a rental property was that it had to be within a reasonable driving distance of our home; we wanted to manage our own property.
We looked into several surrounding cities for potential cashflow
positive properties. We used sites such
as Zillow.com to give us an idea of potential rental income as well as
comparable prices for other recently sold properties. Then we calculated all investment expenses
such as mortgage, insurance, and property taxes. We also determined the capitalization
rate (“cap rate”) of every property that we were interested in. The cap rate is the rate of return based on
the expected income the property will generate.
The cap rate is calculated by dividing the yearly income (after
expenses) of a property by the total value of the property.
Cap Rate = (Yearly
Income) / (Total Value)
The higher the cap rate,
the better the annual return on your investment property. More desirable locations will have a lower
cap rate. Looking at the cap rate is a
quick “rule of thumb” way of comparing multiple opportunities. In our local housing market, a cap rate
greater than 5.0% is considered good. In
other less desirable neighborhoods, you might find properties with a cap rate
greater than 10%.
Example: Let’s say you are comparing two properties
that are both on the market for $500,000, and Property A produces $25,000
income per year and Property B produces $50,000 income per year.
Property A cap rate:
$25,000 / $500,000 = 5%
Property B cap rate:
$50,000 / $500,000 = 10%
While determining a property’s cap rate is a good starting point to
quickly evaluate multiple listings, other factors such as location and
potential for future growth are also important.
What if Property A needs some maintenance and remodeling to make it a
more profitable? Also, what if Property
B is in a location losing popularity?
