Real Estate… Answered

As a landlord, you need to choose your investments carefully. Pick the right property and you’ll bring in profit, month after month, year after year. The opposite is also true. Buy a dud rental property and you can enter a world of frustration and loss that lasts months or years.

For a landlord, each real estate investment is long-term, so it’s essential that you understand what you’re doing. In this post, we are going to dissect the "anatomy" of a good rental property.

Location: The Foundation of Every Real Estate Investment

You’ve heard it before. "Location, location, location!" If real estate investing had a golden rule, "location" would be it. But not in the way most people think. Buying a property in the perfect spot is not a prerequisite for a good real estate investment. Sure, it helps, but what’s really important is understanding the location of your property.

For example, you might buy a property in a questionable neighborhood because you’ll get a great deal and the government will assign you a Section 8 tenant for a respectable rent. Or you might follow the traditional landlord formula and buy a house in a great neighborhood with little cash flow but huge potential for appreciation.

Neither strategy is superior to the other. The point is you need to understand how the location is going to impact your real estate investment:

• What kind of tenant will rent the property?
• Will the home appreciate?
• If so, how much?
• If not, can you create a tax benefit?
• How long will this particular location be a good investment for you?
• When should you move on?

It’s important to know the answer to all of those questions before investing in a property.

Cash Flow: A Landlord’s Lifeblood

One of the benefits of being a landlord is bringing in monthly income from your real estate investments. The income makes your mortgage payment, plus a little profit. Depending on your financing structure, you can pay off a property in 20-30 years without ever making a payment from your own pocket. Your debt to income ratio also improves with each property you buy, theoretically allowing you to buy an unlimited number of houses.

The key to all of those benefits is positive cash flow. If you’re spending $800 per month on your mortgage payment, property manager, taxes, and miscellaneous repairs, then you need to bring in at least $801 per month rent. Otherwise, you’ll have difficulty buying more properties, and you could slip into negative cash flow, causing you to lose money every month. Stay above your expenses, on the other hand, and in 30 years, you should be a very wealthy landlord.

Equity: The All-Important "Padding"

Equity is important for two reasons. If you’re just getting started in real estate investing, it gives you a cushion for mistakes. For example, you might buy a house with an After Repaired Value (ARV) of $100,000 for $60,000, estimate $10,000 in repairs, and expect a monthly rent of $900. With any real estate investment, there’s a chance of being slightly off with your numbers. You might need to make $20,000 of repairs or find out it’s only worth $90,000. But with your extra equity, that’s no sweat. You won’t make as much money as you expected, but you won’t lose money either.

Or it can go the other way. You might have been completely accurate with all of your estimates and sell the property a few years later for a nice little profit. For example, if you pay $400 per month toward the principal, see a 5% appreciation per year, and you hold the property for five years, you will only owe 36,000 on the property and it’ll be worth around $125,000. That’s a nice chunk of equity for when you decide to sell your real estate investment.