How often have have you been told about the importance of diversification in your portfolio?
I imagine that if you have read anything about finances online, spoken to any advisors, happen to have watched Jim Cramer’s Mad Money segment of “Am I Diversified”, you would have been told about the importance of diversification.
Diversifying Your Portfolio with a Rental Property
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What Is Diversification?
Generally, diversification is when you are invested in a variety of different sectors (i.e. stocks, bonds, real estate, crowdfunding, litigation funding, etc) so that if there is a significant drop in one sector, you will be protected by the others.
The absolute worst outcome is if you have all your eggs in one basket (like having everything in a high yield dividend company company), and then you find out there is a problem with the company, or the companies outlook, and you loose out on your investment.
If you are in retirement, and this is your main source of income, then you could be in some serious trouble.
In most cases advisers limit their diversification recommendations to equities or fixed income securities because those are the areas that they know best (and sometimes get paid a commission to recommend). So here, lets take a look at rental income properties.
Rental Income Properties
First let me get the negatives out of the way. Often retail investors do not consider rental properties because of concerns related to maintenance and long periods of vacancy. Others may avoid rental properties because they simply have no experience in the area and they have a fear of starting something new. Lets discuss these a bit more:
Maintenance Issues with Rental Properties
Just as you have maintenance issues with your own home, there will always be maintenance issues with rental properties. . . a window gets broken, the water heater needs to be replaced, a downspout is leaking, etc. If you are the least bit handy, many of the issues that come up can be handled without hiring a professional, however major issues that might relate to furnace, air conditioning, plumbing, etc. are generally best handled by pros.
The most important thing that you can do is to develop a good list of service providers, so, when a problem does occur you have someone to call. If you are not handy or don’t want to deal with small jobs, then adding a local handyman to your list will be super helpful.
Obviously, the more you hire others to do your maintenance the more it cuts into your profit, but as with any business, you should simply budget a reasonable amount for this type of problem resolution, accrue the money, and draw from this kitty as the need arises, just as any business would. Generally, 10% of gross rental income will cover maintenance expenses.
Also depending on where in the world you are living, if the rental is under a business, then you may also be able to claim tax deductions on expenses.
Vacancy and Rental Properties
The best way to avoid vacancy issues comes even before you purchase the rental property.
You have heard realtors say the three most important aspects of buying real estate are location, location, location. This is true with rental properties. Tied in with location, when buying a rental property, the price is more important than when buying a home for personal use. This is because you must determine the relationship between the price you pay and the rent you will be able to generate from the property to insure a solid return on investment. There are a myriad of factors to consider here but for the most part if you can buy a property for less than seven times the annual gross rental income, the math will work out favourably for you, and you will be able to offer the rental at a good rate.
Obviously every situation is different and there are no short cuts when it comes to figuring out each specific deal, but also, it’s not rocket science.
Take your gross income minus all of your costs and you will know whether or not you have a good deal. An great way to determine how much rental income a specific property should generate, if it is not already rented when you buy, is to go on Craig’s List (or your alternative marketplace if not in the US) and find out the going rate for other similar properties.
Screening Rental Tenants
Equally important in avoiding high vacancy rates is to properly screen prospective tenants. Application forms are readily available online as are background checks. The cost for a thorough background check is around $30-35 and is well worth the money. Many landlords request this amount to be submitted with each application. By pricing your units properly, and renting only to proven reliable folks, you will have gone a long way toward eliminating long periods of vacancy.
Looking for Value in Rental Properties
Looking for a value in rental property is different from looking for a home for your family to live in. Your specific taste is unimportant. What is important is how desirable the property is to prospective tenants in the specific price range.
A mistake that is often made is to buy a property and then spend too much money in the rehab process. If you are buying a property in a high end exclusive neighbourhood, then it makes sense to put in the best appliances, top grade carpeting, or hard wood floors, etc.
But if you are buying in more of a mid-income neighbourhood, then any improvements should be focused on function and need, rather than top of the range. Basically, remember who your potential renter is and target the property for them. You are not buying the property for yourself!
Helpful Property Investing Resources
One of the best things that you can do is to learn as much as you can about taking on a rental property. There are so many great books and other information sources out there, including:
- Real Estate Investing QuickStart Guide: The Simplified Beginner’s Guide to Successfully Securing Financing, Closing Your First Deal, and Building … Real Estate – the number 1 best seller book on Amazon in property insurance, which targets new investors looking to create long lasting wealth. The book teaches you about investment basics, and how to flip properties to generate more income.
- Rich Dad Advisors: ABC’S of Buying a Rental Property: How You Can Achieve Financial Freedom in Five Years – written by Ken McElroy who has close to 30 years of experience in property management and development. Currently Ken is the Co-Founder of MC Coimmpaneis who has over 8,000 units throughout America, worth more than $1 billion dollars.
Rental Property Alternatives
If you are not so keen on investing in a whole property yourself, then you could consider looing at platforms that offer fractional ownership instead.
These types of investments are more passive, requiring less initial capital, and you don’t have to deal with the management of the property yourself.
Some fractional property platforms to investigate further include:
- Reinvest24 – This is the platform that I use (you can see my returns here). The platform offers loans for both residential and commercial properties. These include rental apartments, development loans, office spaces, land plots, and commercial spaces, among other things.
- BulkEstate – Another great option that utilises the power of group buying. Overall there are more than 10,000 users on the platform, with 89 units being sold.
If you do choose to invest in a platform, make sure to run your own due diligence to minimise any risks associated with scams.
Taking on a rental property is not for everyone, but for those who are interested in stepping outside of the share market, and are looking to generate a higher return than totally passive investments generate, rental property may be just the thing.
Buying at the right price, having a list of trusted professionals, renting at the right price, and screening prospective tenants thoroughly, will more than likely create a new income stream that will be quite rewarding.
Additionally, buying rental property in the right location offers the possibility of significant capital appreciation. Finding undervalued properties is similar to finding undervalued stocks. It may take some time and effort, but they are out there, and someone is going to buy them. . .why not you?
This was just one of many investing ideas that we have for you. If you want to find out other ways to invest, check out our list of additional investment ideas.