How to Make An Investment in Rental Property Now

by Neal Frankle, CFP ®

Did you make an investment in rental property and lose your shirt? You’re not alone. So many people have lost a ton with their investments in rental property over the last few years that they don’t even want to hear the words “real estate” discussed.

But this might be one of the times when the best investments are in rental property but few people want to hear about it.

Take a look at what’s happened to prices in different markets since 2006. The market in Los Angeles has lost over 30%. That means you can buy real estate at a 30% discount – not too shabby…or is it?

  investment in renal property

While real estate has been a traditional wealth builder (and while I think now is a great time to look at real estate as a great option for investment income), I still believe investors need to be very careful right now.

In my opinion, real estate is all about cash flow. If this wasn’t true in the go-go days from 2000 through 2006, it’s certainly true now. What I mean of course is that you shouldn’t pay more for a property than the rents justify.

Where people got into trouble was when they bought property for the appreciation only (which often didn’t appear). They didn’t care that they needed to shell out hundreds of dollars from their pockets each month on top of the rent they got. Let me show you an example:

A house in a decent neighborhood in Los Angeles was priced at over $1,000,000 in 2006. That house could have been rented out for $3,500 a month. (I know…I know…who would pay $3,500 to rent when they could buy for that monthly amount. I asked myself that question too and never got a good answer…)

Today, that same house goes for about $725,000 and it can still be rented for $3,250. Is now a good time to buy that house?

Not if you are looking at it as an investment.

Here’s why.

The monthly payments on this house (assuming you put 30% down and finance the balance) are about $2,725 a month. That’s without taxes, insurance or vacancy. If you figure all that in, you are still looking at a negative cash flow. While the possibilities for appreciation are greater now than they were two years ago, it’s still a risky deal.

What if you lose a tenant and your job the same month?

What if property taxes go up? What if a tenant causes damage to your rental property? Too much risk for me.

On the other hand, what if you look at other markets.

In my opinion, you should only invest in real estate that pays you 5% (at least) on your 30% down payment AFTER all the expenses are paid. Let’s look at a more moderate example.

Assume you could buy a home for $100,000 with $30,000 down. My advice would be to only do so if, AFTER ALL EXPENSES, you receive $1,500 profit per year. The $1,500 represents a 5% return on your down payment of $30,000. That works out to $125 per month.

If this going to be possible in every market? Nope. It’s not possible in my neighborhood…that’s for sure.

But it is possible in other markets.

Of course, this may require partnering with people outside your stomping grounds…so be it.

Do you have a friend in Florida? How about a chum in Chicago?

Find out what the market is doing. Ask for realtor referrals. Get more than one. Try to get your buddy involved so he or she can go out and inspect the neighborhoods and the house itself. Offer them a piece of the action – a reduced investment in return for their management of the property.

Have you considered an investment in rental property now? How have you dealt with landlord liability? Would you do so outside your own community? Have you ever partnered with a friend? How did it work out?

 

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