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I want to build a small empire of my own over time in real estate. I want to pay 20% for a house and rent it out for a small profit (hopefully make around 3 - 5k a year in profit) and then pay it off as soon as possible. Once I pay the house off, I want to repeat the process over and over again. I have no intentions of selling off my house, rather just keep buying homes and renting the homes out. I don't expect to make a lot of money when I first start, but in the long run I am hoping to make a lot of money. I know this won't be a passive income and will be like a part time job when I start out, but this seems like the best opportunity for me. Both in making money and learning a valuable skill in property management. Also, I will not be spending any money I make in real estate on myself. It will go back into my real estate business, unless something comes up where I have to spend on myself for emergency reasons.

Is there a huge flaw in this plan? Is this something realistic or will this not work out? I know it won't be 100% smooth sailing (nothing in life is), but I feel like this could be a good goal to have.

Edit: Sorry, but I forgot to include this. I am using my own money that I make from my main job as well. So it won't be just the 5k in profit I get from renting. I will only dip into my rental profits if I absolutely have to.

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    If you make 5k a year in profit on a 100k house you bought for 20k down (80k loan), and apply all profit to paying off the housing loan, that's still 10-15 years to pay off the first investment property using rental income alone. A 200k house (180k buy) would take closer to 20-30 years. By "small empire", I assume you meant more than 2-3 lower-end houses owned by retirement. Was there some other math or strategy you had in mind, such as only using the profit to replace your capital and buying a second house as soon as you built up enough principal? – BrianH Dec 29 '16 at 19:08
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    My grandfather and father succeeded at this. So have I. (For some definition of 'empire'.) The #1 lesson I learned, comparing my experience to my relatives: hire a property manager. They'll take 10%, but you'll deal with essentially no mundane issues. Just writing maintenance checks and investing profits. – bishop Dec 29 '16 at 21:36
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    Funny, I had a very similar thought last night, although without the 20% down part - what if you could buy properties with 0% down and charge enough rent to pay the mortgage and all maintenance expenses. Well, in 30 years you would own the properties free and clear. But, you'll have to deal with finding renters and keeping the properties maintained, which is a lot of work, or paying somebody else to do that for you. There is also a lot of risk - what if you can't find renters, or the market rent goes below your costs? – Michael Dec 29 '16 at 23:45
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    @Michael also note that mortgage rates and taxes on investment properties are quite a bit higher than primary residences. – Jared Smith Dec 30 '16 at 12:36
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    Nothing in your plan seems to be specific to today's situation. So, if this were such a great plan, wouldn't the rental market already have consolidated into a small number of empires, leaving you no room to enter? – David Richerby Dec 30 '16 at 18:04
34

The idea you present is not uncommon, many have tried it before. It would be a great step to find landlords in your area and talk to them about lessons learned. It might cost you a lunch or cup of coffee but it could be the best investment you make.

rent it out for a small profit (hopefully make around 3 - 5k a year in profit)

Given the median price of a home is ~220K, and you are investing 44K, you are looking to make between a 6 and 11% profit. I would not classify this as small in the current interest rate environment.

One aspect you are overlooking is risk. What happens if a furnace breaks, or someone does not pay their rent? While some may advocate borrowing money to buy rental real estate all reasonable advisers advocate having sufficient reserves to cover emergencies. Keep in mind that 33% of homes in the US do not have a mortgage and some investment experts advocate only buying rentals with cash.

Currently owning rental property is a really good deal for the owners for a variety of reasons. Markets are cyclical and I bet things will not be as attractive in 10 years or so.

Keep in mind you are borrowing ~220K or whatever you intend to pay. You are on the hook for that. A bank may not lend you the money, and even if they do a couple of false steps could leave you in a deep hole. That should at least give you pause.

All that being said, I really like your gumption. I like your desire and perhaps you should set a goal of owning your first rental property for 5 years from now. In the mean time study and become educated in the business. Perhaps get your real estate license. Perhaps go to work for a property management company to learn the ins and outs of their business. I would do this even if I had a better paying full time job.

  • Another risk is non-fixed mortgages. Optimism is dangerous, prepare for the worst and hope for the best. – jiggunjer Dec 30 '16 at 8:25
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    "Currently owning rental property is a really good deal for the owners for a variety of reasons." - that might be true on average, but rental properties are very sensitive to locale. – Joe Strazzere Jan 1 '17 at 1:06
  • @JoeStrazzere : That is a really good point! Sorry for the assumption, but in my locale, it's a really good time to be a landlord. – Pete B. Jan 2 '17 at 13:30
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A lot of people do this. For example, in my area nice townhouses go for about $400K, so if you have $80,000 you can buy one and rent it. Here are the typical numbers:

Monthly Payment 30-year loan at 4%: $2,027.73 
(Includes Monthly Tax Paid: $416.67) 
Insurance: $80 per month 
Maintenance: $50 per month 
Rental Income: $2,500 per month

So you would make $350 per month or $4,200 per year on $80,000 in capital or about 5% profit. What can go wrong:

(1) The property does not rent and sits vacant. You must come up with $2100 in mortgage payments, taxes, and insurance every month without fail or default.

(2) Unexpected expenses. A new furnaces costs over $5,000. A new roof costs $7,000. A new appliance costs $600 to $2000 depending on how upscale your property is. I just had a toilet fixed for a leaky plunger. It cost me $200. As you can see maintenance expenses can quickly get a lot higher than the $50 shown above... and not only that, if you fix things as cheaply as possible (as most landlords do), not only does that decrease the rentability of the property, but it causes stuff to break sooner.

(3) Deadbeats. Some people will rent your property and then not pay you. Now you have a property with no income, you are spending $2100 per month to pay for it, AND you are facing steep attorney fees to get the deadbeats evicted. They can fight you in court for months.

(4) Damage, wear and tear. Whenever a tenant turns over there is always a lot of broken or worn stuff that has to be fixed. Holes in the wall need to be patched. Busted locks, broken windows, non-working toilets, stains on the carpet, stuck doors, ripped screens, leaky showers, broken tiles, painting exterior trim, painting walls, painting fences, etc. You can spend thousands every time a tenant changes.


Other caveats:

Banks are much more strict about loaning to non home owners. You usually have to have reserve income. So, if you have little or no income, or you are stretched already, it will be difficult to get commercial loans. For example, lets say your take-home pay is $7,000 and you have no mortgage at all (you rent), then it is fine, the bank will loan you the money. But lets say you only have $5,000 in take home pay and you have an $1,800 mortgage on your own home. In that case it is very unlikely a bank will allow you to assume a 2nd mortgage on a rental property. The more you try to borrow, the more reserve income the bank will require. This tends to set a limit on how much you can leverage.

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    $600/yr on a $400k house? The snow plowing can be 2x that per season, the lawn mowing/landscape cost can be 2x too. The cost to paint the house should be divided by the years between paint jobs. All in all, that $4200 is zero even if rented 100% with perfect tenants. – JoeTaxpayer Dec 30 '16 at 3:02
  • @JoeTaxpayer Obviously the numbers provided are just to give an example; I can tell you though that $400K townhouses in my area do rent for around $2500 per month typically. – Five Bagger Dec 30 '16 at 3:34
  • @FiveBagger Regarding point (3) Deadbeats, this problem can be reduced by asking the tenant to bring a signed letter from their previous landlord indicating that they have paid their monthly rental regularly and so on. Or you can contact their previous landlord by yourself. – sky-light Dec 30 '16 at 5:02
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    @sky-light and how do you know that letter comes from their previous landlord and not their grandmother? That requirement could also deter potential good tenants. – jiggunjer Dec 30 '16 at 8:33
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    @FiveBagger - a monthly rent below 1% of the home value is very likely to turn unprofitable. I was offering a number of standard costs, not even a worst-case scenario. Unfortunately your example ignored the regular routine costs we all face. Similar to trying to answer the cost of home ownership, one should start with the longest cycle, the 20 year life of the roof. Then assign a life to all the appliances that are going to break over time. Divide all of these costs to get a $$/yr and you'll see how much you are really ignoring. – JoeTaxpayer Dec 30 '16 at 14:46
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This is a reasonable idea and many people have done it. But there are some risks that you need to mitigate.

  1. Overleverage. If mandatory payments are more than you can handle, you could lose your property. Think you get laid off during a recession when all your houses are empty.
  2. Managing property is a lot of work. A friend does this, but to keep 7 properties going she basically works full time on it. A lot of this is renovating the units as they go empty so they are easily rented. She is very handy and you will need to be handy too.
  3. Systemic risk. Suppose you buy all your properties in Space City. The town is prosperous due to the space port there and the rental market is strong. Then suddenly the space port closes permanently and most of the workers move away. Suddenly the rental market tanks and the value of the properties decline by 60%. You can't rent the units for much and have to sell out at a fraction of what you paid for them.

This is a viable business model, but it is a business and you need to treat it as such and expect to work quite hard at it.

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    +1 for the "work hard at it". I spent many a "vacation" working on my 5 unit. – Jared Smith Dec 30 '16 at 12:38
4

This is a common and good game-plan to learn valuable life skills and build a supplemental income. Eventually, it could become a primary income, and your strategic risk is overall relatively low. If you are diligent and patient, you are likely to succeed, but at a rate that is so slow that the primary beneficiaries of your efforts may be your children and their children. Which is good!

It is a bad gameplan for building an "empire." Why? Because you are not the first person in your town with this idea. Probably not even the first person on the block. And among those people, some will be willing to take far more extravagant risks. Some will be better capitalized to begin with. Some will have institutional history with the market along with all the access and insider information that comes with it.

As far as we know, you have none of that. Any market condition that yields a profit for you in this space, will yield a larger one for them. In a downturn, they will be able to absorb larger losses than you. So, if your approach is to build an empire, you need to take on a considerably riskier approach, engage with the market in a more direct and time-consuming way, and be prepared to deal with the consequences if those risks play out the wrong way.

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    tldr: the asker is a new player, so they have a lot of catch-up to do, and that makes the game harder. – Nij Dec 30 '16 at 1:59
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This is a well worn path and not a bad idea. There are quite a few pitfalls but there are a lot of resources to learn for other people's mistakes. Having a plan and doing your research should help you avoid most of them. Here is some general advice to help get you started on the right foot.

Know the market you are investing in. The city should have more than one major employer. The population should be rising and hopefully there are other positive economic indicators. Check the city's and state's chamber of commerce for useful information. You do not want to be stuck holding a bunch of upside down property in Detroit.

Accurately calculate expenses. Set aside money for repairs. budget 5% of the rent or 100 a month for repairs if no repairs happen that money goes into the repair fund for the future. Set aside money for capital expenditures if the roof has a 10 years of life left in 10 years you better be ready to replace it same with any major appliances. Your area should have a baseline vacancy rate 5-8% in my area. That says out of a year your property will be vacant for around 6% of the year or 21 days for turnover. You should build that cushion into the budget as well setting aside a portion of the rent to cover that lean period. Some property management will offer "eviction insurance" which is basically them enforcing that savings.

Financing maybe difficult a lot of banks like to see 25% down payments on investments. You will also face higher interest rates for investment properties. Banks generally also like to see enough money to cover 6 months worth of expenses in your account for all property. Some banks will not give financing for investment property to someone without 1-2 years of landlord experience. All in all finding money will be hard when you gets started and your terms may be less than ideal.

(hopefully make around 3 - 5k a year in profit)

If that includes loan pay-down and is not just cash-flow you are probably in the right ballpark. I can find $100-$200 dollars cash-flow a month on single family home in my area. Once loan pay-down is included your numbers are close.

It sounds like you have a good attitude and a good plan. A book that I really enjoyed and I think may be useful is "Start Small, Profit Big in Real Estate" by Jay DeCima. I think of it as required reading for do-it-yourself real estate investors.

Good luck and happy investing

1

This can be done, and there have been many good suggestions on things to do and watch out for. But to my shock I don't see anyone offering any words of caution about property managers!

Whatever you do, don't assume they have your best interests at heart. Do not assume that "no news is good news" and that if you aren't hearing of problems and are just collecting rent checks, everything must be fine.

You can easily end up with tenants you would never have allowed yourself, or tenants with pets that you would not have allowed, etc. Especially if the manager doesn't want you to have a vacancy and potentially lose you as a client, they may very well lower their standards just to get the place occupied. And a year or two or three later, you may find yourself looking at a very large repair bill and wonder how on earth it could have happened when you supposedly had someone looking out for your property!

There are quality, ethical property managers out there. They are not all bad to be certain. But whatever you do, check up on them. And with multiple properties - especially if in multiple areas/states etc. - this can be nearly a full time job in itself. As the saying goes, "Trust, but verify". I have never found this to apply more than with rental properties and property management.

Don't leave anything significant to them 100%. You can't even assume that a rule like "all expenses over $50 must be cleared by me first", as that can simply mean that they don't bother to come to you for certain kinds of repairs that would cost more than that, or that they just get them "taken care of" by their own person (done poorly, illegally, etc.) and never tell you. Never trust their choice of tenants blindly. Visit the place yourself at least every few months - a quick driveby at a minimum or better if you can, arrange a reason to walk through the house personally. Check the back yard, never assume that the front yard is indicative of anything else. Never assume that a "no pets" rule will be followed, or that tenants wouldn't lie to the management about having pets. Never assume that the tenants won't move additional people into the property as well.

Always expect a bare minimum of 1 month vacancy every year, and an additional minimum of 1 month's rental revenue in unexpected maintenance/repairs every year. This is at a minimum! You might do much better than this, and have a high quality tenant in place for years who costs next to nothing in extra maintenance. But do not count on it.

Rental real estate investing looks so simple on paper, where it's just numbers. But reality has a very rude habit of surprising you when you least expect it.

After all, no one expects the Spanish Inquisition!

Good luck!

0

I have done something similar to this myself. What you are suggesting is a sound theory and it works.

The issues are (which is why it's the reason not everyone does it) :

  • The initial cost is great, many people in their 20s or 30s cannot afford their own home, let alone buy second properties.

  • The time to build up a portfolio is very long term and is best for a pension investment.

  • it's often not best for diversification - you've heard not putting all your eggs in one basket? With property deposits, you need to put a lot of eggs in to make it work and this can leave you vulnerable.

  • there can be lots of work involved. Renovating is a huge pain and cost and you've already mentioned tennants not paying!

  • unlike a bank account or bonds/shares etc. You cannot get to your savings/investments quickly if you need to (or find an opportunity)

But after considering these and deciding the plunge is worth it, I would say go for it, be a good landlord, with good quality property and you'll have a great nest egg.

If you try just one and see how it goes, with population increase, in a safe (respectable) location, the value of the investment should continue to rise (which it doesn't in a bank) and you can expect a 5%+ rental return (very hard to find in cash account!)

Hope it goes well!

0

BEFORE you invest in a house, make sure you account for all the returns, risks and costs, and compare them to returns, risks and costs of other investments.

If you invest 20% of a house's value in another investment, you would also expect a return. You also probably will not have the cost interest for the balance (80% of ???).

I have heard people say "If I have a rental property, I'm just throwing away money - I'll have nothing at the end" - if you get an interest-only loan, the same will apply, if you pay off your mortgage, you're paying a lot more - you could save/invest the extra, and then you WILL have something at the end (+interest). If you want to compare renting and owning, count the interest against the rental incoming against lost revenue (for however much actual money you've invested so far) + interest.

I've done the sums here (renting vs. owning, which IS slightly different - e.g. my house will never be empty, I pay extra if I want a different house/location). Not counting for the up-front costs (real estate, mortgage establishment etc), and not accounting for house price fluctuations, I get about the same "return" on buying as investing at the bank.

Houses do, of course, fluctuate, both up and down (risk!), usually up in the long term. On the other hand, many people do lose out big time - some friends of mine invested when the market was high (everyone was investing in houses), they paid off as much as they could, then the price dropped, and they panicked and sold for even less than they bought for. The same applies if, in your example, house prices drop too much, so you owe more than the house is worth - the bank may force you to sell (or offer your own house as collateral).

Don't forget about the hidden costs - lawn mowing and snow shoveling were mentioned, insurance, maintenance, etc - and risks like fluctuating rental prices, bad tenants, tenants moving on (loss of incoming, cleaning expenses, tidying up the place etc)....

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