I don't have any properties but I like the idea of it, my risk tolerance just isn't sufficient to pull the trigger. My other issue is that I live in a very hot real estate market with dramatic year over year growth. It takes more money to get a property here, and the competition for good rental properties is fierce with cash buyers from all over the world buying up properties here.
I think the advantage you are overlooking is the ability to leverage money and use the debt to your advantage, particularly with mortgage rates as low as they are. I don't think the people that are buying up a bunch of properties are focused on large down payments, they are more focused on the monthly cash flow to make sure the investment makes sense. If you have the financial means to take out several mortgages and are confident you can keep the properties occupied, the tenants pay your mortgage payments for you while you build equity and also hopefully see the value of the properties increase over time. Putting more money down to lessen the risk of ending up with mortgage payments that you can't handle comes at the expense of leveraging debt to invest in more properties. I think those that are doing it well are putting down minimum payments so they can take on more properties and leverage their money even further.
You are correct about leveraging but obviously the more you leverage the more risk you assume. Here are my thoughts for anyone looking to do this and I mean anyone because I didn't start out with much.
Invest in the market first to build up money that can be used for properties, decide on your target market, buy the neighborhood even more so than the home, don't buy with emotional attachment but rather with a investor's mindset, leverage to the point that you are able and with which you are comfortable, determine cash flow viability first and then estimate long term ROI, manage as many of the properties yourself, keep tenants happy and the property looking good.
1) I lived like a college kid for a few years after commissioning so most of my money went into mutual funds at the time and had built up about a $10k bank account for emergencies. I was so frugal that I slept on the floor of my first place in my military issued sleeping bag for over a month before I bought a bedroom suite that I liked at a very low price. You may not go this extreme but it helped me get the funds to buy my first property pretty early despite not having any money coming out of college. In my view, it's important to continue investing in the market heavily early in your life even while buying rental properties. You don't want all of your eggs in one basket.
2) Decide on your target market. For me that was people like me. Some people like low end properties or to stuff as many college kids in a place as legally allowed because it may have higher margins. It also has higher headaches. I chose properties that would be desirable to young professionals, young couples, retirees downsizing that didn't want to do spend their time with outside maintenance, etc. These segments generally pay their rent on time and make the place a home therefore keeping it nice and letting me know if there are issues that I should address. They are also easier with which to work and don't leave the place in complete shambles as much when they move out. You never know exactly but spending a lot of effort on finding the right tenants in saves you so much effort down the line.
3) Buy neighborhoods even more so than the home. I look for desirable neighborhoods within short walking distances from nice amenities. Right near a park, a short walk to the elementary or middle school, short walk to movie theater, easy commute to the bigger employers, etc. When people buy houses to live in for a long time these things are important but not as important as the house itself. I think for rental properties it is almost more important than the house. Prospective tenants that fit my target market start looking in these neighborhoods until they find a suitable house to rent.
4) Buy with an investor's mindset and without emotional attachment. I wanted the best value for my money not the house that had the most. This was easy to do as a young guy buying a place to live in for 2 to 3 years before I met my wife. Perhaps it's my bias showing but wives (mine in particular) buy with emotional attachment. They see the perfect house, envision living in it, and then pay what the seller wants to secure that vision. My vision was to conduct some market research before hand and determine the best neighborhoods, see as many houses as possible in those neighborhoods, build a spreadsheet outlining their number of bedrooms, baths, square footage, age, previous selling points and dates, and then do my own market comps by looking up sales of all of the other houses in the neighborhood. I then used this information to determine my price for each house that I saw and prioritized which houses would best perform as a rental (how much rent does it command, how easy would it be to rent and maintain it, what is the trend in the value of the property, is it a style that will be as desirable 10 years from now or is it a trendy fad style that limits the number of potential renters?). Now I start with my top prioritized home that I saw and put in a low but potentially negotiating worthy offer. If the owner is offended, then I didn't waste their or my time and we can both move on. If they do negotiate, I stay pretty low. If not this house, I have probably at least 10 more that I saw that meet my needs. I settle fast and that is what many sellers are looking for based on their needs so often they are willing to accept a lower offer. There are lots of people that prioritize selling and closing fast and I would love to give that to them at the right value. This is an investment.
4) Leverage to the point you are comfortable. I never go above 20% and used my VA loan with 0 down. My 2nd property was only 10% and took on PMI but I only did that because I was still very young and building up my funds so I didn't want to break into my investments in the market. I wouldn't pay PMI if you have the funds available to avoid it. It's a cash flow depressor and significantly reduces the long term ROI for the investment. Some people over leverage themselves and that is easy to do if you bought properties that don't rent easily. Turnover happens and if you are over leveraged and not bringing in rent then you could put yourself in a bind. I was very aggressive when I was younger and some of my philosophies and maybe good fortune allowed me to do that successfully.
5) Positive cash flow is critical. I bought and lived in places for 2-3 years but always had tenants lined up before I moved. Some of that was buying the right properties. Some was advertising and curb appeal. Some was knowing the market and the transient nature of either living near a military installation or a major university. Both of those locations have very well defined rental cycles. The bulk of the people in those locations move in the summer and a second smaller push in the winter. So you have to do a full court press at those times. If you are buying a rental property in an area that isn't as cyclical then you need a different strategy. Fortunately, I always capitalize on the boom of the cycle because I bought properties in the most desirable neighborhoods, close to amenities, and bought at a value that I could offer a reasonable rent. So I often line up as many as a dozen prospective tenants for the same day showing in half hour increments. Usually at least half want to rent the well maintained property and many fill out the rental application before leaving often as the next prospective tenant showing starts. So I do background checks and determine the best fit as soon as possible and lock them into a year or 2 year lease. I often prioritize how long they are willing to commit because turnover kills cash flow and adds expenses. I look for properties that maximize cash flow by limiting time not rented, limiting turnover, buying at a strong value (low cost relative to rent potential), reducing monthly costs, and hopefully self-managed or close to my dad who managed some properties as well. The stronger your positive cash flow the more you reduce your risk should turnover occur and you don't immediately get someone in there. Lastly, you do want to have chosen a property that will increase in value over time.
6) Self-manage or you better have someone you trust managing it. Large property management companies don't have the same level of interest in your property that you do. Maintenance, tenant filling, holding tenants accountable for non-normal wear and tear damages, etc. can be bad with a large company. They may prefer to steer a tenant to another property first because it makes them more money. I have a buddy that I worked with who had new carpet throughout when he left a place and the property management company told him he had to replace them after the first tenants moved out a year later and they hadn't retained any of the security deposit. Plus, you or someone you trust can often do repairs, turnover cleaning, and advertising/showing much cheaper and better than a large property management company.
7) Keep the tenants happy, don't nickel and dime them, and keep the property maintained. Every turnover costs you. You want happy tenants staying as long as possible and making the place home. In addition to all I mentioned in a post above, I also don't raise rent on people usually for 3 to 5 years. Eventually you may have to maintain the strong cash flow needed to keep it going successfully. But raising rent sucks and you might drive unnecessary turnover that will cost more than the additional rent you are trying to pull. You can advertise at a higher rent after someone moves and bring in new tenants that find that to be a reasonable rent. But mostly, I want good people happy to stay, paying their rent consistently, making the place a home and letting me know when something might need fixed or replaced, and wanting to leave the place as they found it when it's time to move.
Now admittingly I had some major advantages getting started. I didn't marry early in my career and so I could invest heavily, build up funds, live on less, buy houses with an investor's mindset, etc. I also was receiving non-taxable housing pay based on rental rates in the area I was stationed from the military which I invested in properties. I also deployed a few times in which I both received housing pay AND rented my property at the same time plus combat pay. It was like a nitro boost to funding my next property purchase. My dad was a huge help to me particularly while I was deployed or half way across the country in the military. He managed properties and is extremely handy, much more than I. I still give him 10% of rental incomes even though I do it all now but he helped me build it. But some others have other advantages, maybe they are more established, know their market because they've lived there 30 years, had more money to start out investing than I did coming out of college with basically nothing. Good luck if pursuing this investment type and let us know how you make out.
