Investing in rental property is one of the few proven ways to build wealth. Many small investors have been able to retire early with their rental income. I love our dividend income because it is a lot less work than being a landlord, but owning rental properties has been a boon for us as well. Today, I’ll share our story, go over how to start investing in rental properties, and answer a few basic questions.
The easiest way to start investing in rental property
The easiest way to start investing in rental property is to convert your old home into one. This is a great natural progression because many of us purchased a starter home when we were young. Once we start a family, we’ll need a little more space so we’ll upgrade to a bigger home. Most people would sell their old home and use the money for the down payment on the new home. Usually selling also means some extra cash to furnish the bigger home as well. However, investors should consider renting out their old home instead. This is a perfect opportunity to build another income stream and it was how we got started with rental properties.
How we got started
In 2000, we purchased a moderate single family home near my old employer for a convenient commute. We lived there for 7 years, but decided to move to a smaller condo in downtown, Portland. By that time, Mrs. RB40 was working in Portland and it took her 90 minutes to commute every day. It was easier for me to drive to the suburbs than for her to take the light rail to work. Also, we used to live downtown before buying the house, and we liked it more than living in the suburbs.
When we moved, we decided to rent out our old home instead of selling it. Our main motivation was to build wealth through passive income and property appreciation. At that time, I was just starting to figure out that passive income is better than active income.
At first, we got a property manager because I wasn’t comfortable being a landlord. This worked well for a couple of years until the property management company consolidated and stop servicing our area. By that time, we had a stable tenant and I decided to try being more hands on. This was fine because we had a good long term tenant and the house was in good shape. However, we decided to sell in 2014 when they moved out. This was mostly because I wanted a rental that’s closer to where we lived. It took too long to drive out to the property and it became more difficult when we had a baby.
We purchased our old home for $209,000 in 2000 and sold it in 2014 for $346,000. (Keep in mind, our initial investment was 20% or about $40,000.) The tenants were paying down the mortgage for us from 2007 to 2014, that’s half of the time we owned it. If we kept the place, eventually it would have been paid off and we’d have a nice monthly passive income. Anyway, our current rental is only a few minutes away and it easier to keep a close eye on it. So that’s how we got started with our rental properties.
Why start with your old home?
Renting out your old home is the easiest way to try being a landlord. It’s intimidating to search for a rental home when you’re new to it. It’s much easier to find a new primary residence because you know all the criteria. Getting a mortgage loan for a rental property is also more difficult than for a primary residence. If you have enough money to put down on a new home without having to sell, then why not try being a landlord. You can always sell the old place if it doesn’t work out.
Here are some more good reasons why you should start by renting out your old home.
You know the property – We lived in our old home for 7 years so we knew all the problematic areas. I knew we’d need new exterior paint in a few years, the fence had some rotten spots, and the carpet piled up in certain areas. In contrast, you never know what problem you’re going to get with a property you haven’t lived in. Our rental duplex had an antiquated electrical wiring system and we had to spend about $1,000 to bring it up to code. We got the inspection report, but it still takes time to become familiar with a property.
Primary residence has better mortgage terms – It’s much easier to obtain a mortgage for a primary residence than a rental property. In my experience, the requirement is much less stringent than when you’re getting a mortgage for an investment property. You can also put less money down on a primary residence. The last time I got a rental property, the bank wanted 25% down and required quite a bit of extra documents. The interest rate is also a little bit better with primary residence mortgage.
Inflation adjusted investment – When we purchased our old home in 2000, our mortgage payment was around $1,200 per month. This was a lot of money at the time because we didn’t have that much income back then. The rate was also pretty high in 2000. By 2014, we refinanced and brought our payment down to $900 per month. This was very affordable for us. Inflation helped us in 2 ways.
- We made more income – As we progressed in our careers, we got promotions and cost of living adjustments.
- Rent increase – We were able to raise the rent. Our tenants helped us pay down a bigger chunk of the mortgage more every year.
Rental properties work well because the mortgage remains the same (or lower) while the rent can go slowly increase every year. This means our income increases faster than our expenses.
All in all, renting out your old home is the easiest way to try being a landlord. If it doesn’t work out, you can sell the place and call it good.
Alternatives to being a landlord
I realize that being a landlord isn’t for everyone. For example, Mrs. RB40 would never consider being a landlord if I wasn’t around. She thinks it is too much of a headache, especially if you end up with a problematic tenant. Fortunately, there are other ways to invest in real estate.
The easiest way is to invest in a REIT index fund, Real Estate Investment Trust. A REIT is a company that invests in real estate. We have some investment in Vanguard’s REIT index, VNQ. That’s a bunch of REIT companies and it’s a painless way to benefit from real estate. You could also invest in individual REIT if you want to focus on certain sector like healthcare or commercial properties.
A new way to invest in real estate is through real estate crowdfunding. Investors pool their money to fund a project which is managed by a local company. I just opened an account at out Realty Shares and I plan to invest about $10,000 in 2017. Realty Shares vetted the projects, but you can do your own research and invest in the areas that you like. Each investment is different and the minimum investment is from $2,000 to $25,000. This is a new way to invest in real estate and I want to see if it will be a good passive income stream.
Now, some questions from the readers.
Where do you list your rental?
Our rentals are located in a popular area with pedestrian traffic. I listed the units on Craigslist and I was able to fill them pretty quickly. I’ve seen “For Rent” signs on the neighboring units and I think that works well for that area, too.
How do you find, screen, and select good tenants
Finding tenants hasn’t been a problem for us. Our units are in a good location and there are many young professionals in the area. We also have been pretty lucky with screening the tenants. Here is what I look for.
- Income and profession. The tenant should be able to comfortably pay the rent. At the most, the rent should be 30% of their income. Anything higher than this and they might have some problem paying. So if the rent is $1,000 per month, the tenant should make at least $3,335 per month. 20% would be even better. I also focus on the profession. The last time I screened for tenants, I had a Nike employee, a musician, a software engineer, and an hourly employee. The Nike employee just moved to the US and had no credit history so he was out. Guess who I picked?
- Credit history – I used e-renter.com to check the tenant’s credit history and criminal record. At e-renter.com, you can set the acceptable credit range, but you don’t see the exact credit score. So A is 776 – 850. The renter’s credit score must be at least 776 to qualify for my property.
- Rental history – I called the previous landlord to see if they had any problem with the tenant.
- Meet with tenant – I met with the prospective tenants to show the place and get a feel for them. I think you can’t rush this one. If the tenant feels off, then just keep looking. All the tenants I talked to were pretty nice.
Which rental application to use?
I used the rental application from e-renter.com. I forgot where I got the lease from, but I downloaded it from the internet and added more clauses to it.
How to make sure that you get paid on time – do you get paid by check, cash or do you debit straight from a bank account?
I ask the tenant to set up automatic payment from their bank account so I get the payment check every month. One tenant lives nearby and he prefers to drop the check off in person. That’s fine, too. He usually pays on time, but I had to call or text him once in a while.
How do you find a good handyman for property maintenance?
This one is tough. I usually do minor maintenance myself, but I had to hire a few handymen, too. I usually check Yelp and Angie’s List for recommendations. The problem is that they are all really busy and it usually comes down to who can get there the soonest. It’d be great if I can find a local handyman I can rely on consistently instead of going to a handyman company. Readers, do you have any tips?
How do you evict bad tenants legally?
Fortunately, we haven’t had to deal with this one. Every state has different eviction laws so I can’t really help here. Your best bet is to learn more on the internet and see if you can get some legal help. My father in law is actually dealing with this in California and it sounds like a nightmare…
Any more questions?
We have been very fortunate with our rental properties. Our current units are relatively easy to manage and our tenants are really great. We have also sold properties when they became problematic so I can understand why some people don’t like being a landlord. I still think it is worth it because owning rental properties is a great way to build wealth over time. Even if you don’t want to be a landlord, you can still invest in real estate through REIT companies or crowdfunding platforms like Realty Shares. It’s good to have some alternative investments in your portfolio other than stocks and bonds.