Part II: The Mechanics of Rental Agreement Investment, Leverage, and Monthly Cash Flow
The Absentee Landlord Rental
Welcome to Part II of the Absentee Landlord Series, where it’s time to stop dreaming and start implementing our rental investment plan. Do you have your dream budget figure yet? In Part I, we set it at $2,020, which might seem low to you, but remember that living abroad is generally far cheaper than living in the States. Still, just to appease you, we’ll raise it to $3,000/month required budget.
Building a Rental Agreement Portfolio
All right, we’re starting with little money, and aiming for $3,000/month cash flow. To get there, our goal is to eventually own four rental units, each with a rental agreement signed for $900/month, and owned free and clear of any liens. You will still owe taxes and insurance, for which we’ve budgeted $100/month/rental property, and you will owe commission to a property management company, which we’ll estimate at $50/month/property. This will leave you $750/month/property cash flow, or $3,000/month.
We now have a specific goal for investment properties, with a set rental agreement outline, and we need to somehow accomplish this.
You will need SOME initial capital to get started; for the sake of argument we’ll assume you have $10,000 as startup capital. Here’s how we’re going to leverage that $10,000 into $300,000 worth of rental properties:
You buy a shell, in need of total renovation, in a neighborhood with low vacancy rates and rising demand for housing (more on choosing neighborhoods later). You put down $10,000, and you borrow the rest in the form of a renovation loan. By way of example, let’s say you purchase this shell for $20,000, it needs $45,000 in renovations, and will be worth $100,000 when completed, but of course you’ll have two rounds of closing costs, so let’s tack on another $10,000, and you’ll have carrying costs, so we’ll add another $3,000. This leaves you with roughly $22,000 in equity, to either sell or cash out in the form of a refinance.
Let’s say that you refinance the property and pull out your original $10,000, and meanwhile sign a rental agreement with a tenant for $900/month. You now have your $10,000 back, plus month cash flow of a few hundred bucks, plus roughly $12,000 in equity in a rental property, that will hopefully rise over time as the rental property appreciates. This process can be repeated a few times, to start building a portfolio.
Absentee Landlord Ski Chalet
You now own half a dozen or so of these rental properties, and it’s getting to be a little much to manage on your own. So, seeing that the market is decent in your target neighborhood, you sell all but one of these rental properties, and use the proceeds to pay off the remaining rental property you decided to keep (the one with the best tenant, and the best long-term potential for appreciation). You now have $750 in cash flow, which is actually less than you had before… why did you sell out and pay off the one rental property?
One reason is liability; there is some liability risk involved in owning rental properties, and the fewer you own, the less the risk. Another is that you will soon have a property management company charging you commission, based on the total amount of the rent they collect, not based on your mortgages or cash flow.
There are variations on this model, such as selling each property as you finish it, whether to a homeowner or to a fellow real estate investor, and using the cash to buy more properties. Here’s one variation that deserves a closer look:
At a certain point in building your rental agreement portfolio, you should buy one or two multi-unit buildings, renovate them, screen carefully with a strenuous rental application process, and sign a long-term rental agreement for each unit. These will be more costly to buy and renovate, and thus more costly to pay off, but you will achieve far better monthly cash flow with these, and may only need one multi-unit building to accomplish your cash flow goal of $3,000/month.
Are you with me so far? The trick is to own as few rental properties as possible, with the highest and longest rental agreement possible on each. So, as you create equity in your investing, you can sell the properties to pay off one or two rental properties.
In The Absentee Landlord Part III, we’ll talk about going mobile, hiring a property management company, and reaching your Destination from Part I.
Links to The Absentee Landlord Part I and The Absentee Landlord Part III
Customizable Rental Agreement and Free Rental Application through EZ Landlord Forms
