Your chances of success in property investing can be improved with a little thought. The major enemy is complacency. You must be absolutely certain that the project is profitable.
There are many instances in life where experience is a valuable commodity. Personal experience can be very costly and property rental is no exception. A single bad investment can destroy your chances of success. The wise investor will look to the experience of others, particularly in the early years. Also remember that you are never too old to make a mistake.
So let us rely on the wisdom of others until we have enough of our own.
The inexperienced investor can usually be spotted at the property auctions. He will be the one that outbids you at the auctions. Not that outbidding you will signify his downfall. In fact it must be a reasonable investment since you came to the auction with a view to buying it yourself. He probably did the same research that you did to establish the liability of the area. He probably already knows that the property will rent for $ 800 per month. So what do I know that he does not?
Well, perhaps more properly I should explain why I stopped bidding at that price. I intend to initially owe 30% of the purchase price on each of my properties. A 30% mortgage on the price at which I dropped out would cost me $ 300 per month. I never buy a property without it pays me $ 100 per month. Therefore, to me, the property is over-priced.
This is the point where the uninitiated would say that, in this case, the property is paying you more than $ 100 per month. Some may even say that it is paying you $ 500 per month. That is $ 800 rent less $ 300 mortgage.
Nothing wrong with the math, except that experienced property investors would say “do not forget the 50% rule”.
This is how it goes. 50% of each month's rent is already spoken for. There are contingencies that will occur, for which payment must be made. In my earlier example, setting aside 50% of the $ 800 rent leaves $ 400, from which the mortgage of $ 300 must be paid, leaving $ 100.
Asking less than 50% of the rent for contingencies could prove disastrous. Many investors new to the rental market may find this surprising and wonder what could possibly cost such a high percentage.
At this point we should possibly remind ourselves that owning rental property is a long term investment. We may occasionally take advantage of a quick profit by flipping a property, but our main aim is a profitable portfolio producing long term gains. By its very nature a long term business will attract expenses, which among others are:
Utilities- while the property is unoccupied
Property Management – even if you manage the properties yourself, there will be occasions when you may need a professional
Turnover Costs – renewal of items at a tenancy change
Lawn and garden care.
Then, since we are relying on the income from tenants to service the property, we must not ignore the interruptions in rent, which are: –
If you do not receive the rent you may well evict the tenant, but that will not happen overnight. You may be weeks or even months getting them out.
How long will it be between one tenant leaving and finding a suitable replacement?
If the property remains un-let for any period of time you may feel forced to offer a free first month for example.
Here we are considering partially variable costs, but we must include the fixed or capital costs.
The boiler will need replacement before 15 years.
The roof will surprisingly need replacing before too long.
When presented with these points ago some time ago by my mentor, I recall saying that if my property needs a new roof or a new boiler then I would sell it double quick. My mentor said that he would be pleased to buy such a property from me but that he would expect a price reduction considering significantly higher than the cost of the replacement. Now, many years later, so would I.
There you have it, capital costs have to be factored in. You are going to pay them, one way or another. Better to allow for them sooner than be done out later.
I stick to the 50% rule myself although I could possibly make a slight reduction in my own case.
Although I started out determined that I would be a sole trader and that I would never have any employees, I have relented and now employ a full time property manager.
This came about because in the early days I went along with the property agent's standard contract wherein I had to pay an annual renewal fee for each of the properties where they had produced the tenant.
This was not the highest amount that I paid them in the course of a year but it ranked a bit since it seemed to me that the renewal contract that they produced only had a date change from the previous one. Now I did not want to do a property agents job myself, so a rethink was called for.
My lawyer and account calculated the changes that I would need to make and how the change would affect my bottom line and would not you know I was better off employing someone to manage the whole business for less than I was spending in agent's fees.
I approached the three realtors that had been of most help to me over the years to see if any of them would consider leaving their agency and they all said that they would. Fortunately for me I found this out before I told them of the package that I had in mind, otherwise I could have broken my cardinal rule and paid too much. Interesting though, to think that all of those agency employees that I approach should have such a high level of dissatisfaction with their jobs that they would leave at the drop of a hat.
Just a point about the contract renewal that got me started on this rant. We all know that you have to read a contract before you sign it but it is much more important to understand it. If you are not a lawyer take it to someone who is. If there is a back door in it he can close it for you. Happy investing.