August 11, 2022

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Real estate investing may be the best (or at least the fastest and most predictable)...

Real estate investing may be the best (or at least the fastest and most predictable) way to build wealth in the 21st century. It’s surprisingly accessible to the masses and provides far greater upside and less risk than most other forms of investing, such as stocks. And when it comes to the different types of real estate investing, residential rental properties emerge as a clear winner for the average investor.

Rental Property Investing Principles to Live By

If you want to be successful with rental property investing, it’s simply a matter of understanding a few key principles and consistently applying them over and over again. Here are a few that we recommend:

1. Cash Flow is King

When buying a rental property, cash flow is the primary focus. More specifically, you want to think about your cash-on-cash return. If the numbers don’t add up, it’s not a good investment. It’s as simple as that.

Every good investor should have a target number in their head. Whether it’s 6 percent, 10 percent, or even 15 percent, you need a specific rate of return that you’re looking for. This helps you objectively analyze deals and remove emotions from the picture.

2. Buy Properties With Upside

While cash flow is ultimately what you’re seeking with a rental property investment, it doesn’t hurt to think about long-term property value. In fact, in an ideal world, any property you buy would meet your ROI goals and still have some upside.

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This upside could come in the form of renovations, opportunities to add more square footage, or even just buying in an up-and-coming neighborhood that you believe will be more valuable in a few years.

3. Partner With a Property Manager

Unless you enjoy midnight phone calls from frantic tenants when the AC unit breaks, you’ll want to hire a property manager to handle the day-to-day tasks of overseeing your properties and managing relationships with renters. Good property managers will provide a variety of services, including tenant screening, property marketing, rent collection, repairs and maintenance, and even financial bookkeeping.

4. Be Meticulous With Screening

Tenant screening isn’t a very fun activity, but it’s one of the most essential ones. It’s not enough to just ask a tenant if they make enough money to cover the rent. You need to dig in and really find out who someone is before signing a lease agreement.

Meticulous tenant screening means doing everything legally possible to measure their likelihood of being a good tenant. This may include running a background check, verifying income, speaking with past landlords, and having a one-on-one meeting where you gather information.

Again, if this sounds like something you don’t want to do, your property management company can handle this on your behalf. (Just make sure you research their screening process to get a feel for what steps they’ll take.) Some property managers even offer rental income guarantees on tenants that they screen and place.

5. Keep Cash on Hand

When owning a rental property, you have to be prepared for anything. (The recent pandemic is the perfect example.) And while you can’t always insulate yourself from all risk, you can set yourself up for long-term success by keeping adequate cash reserves on hand. In financial terms, we call this an emergency fund.

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Each rental property you own should have an emergency fund that consists of at least three to six months of operating expenses. That means if it costs you $1,500 per month to pay the mortgage, taxes, and utilities, you want to reach a point where you have somewhere between $4,500 to $9,000 in liquid cash sitting in a dedicated checking account.

You don’t have to build up your emergency fund overnight, but you should slowly add to it each month. You can start by setting aside 15 to 20 percent of your monthly net profit in the account. (Or you could choose to be even more aggressive and put 50 to 100 percent of your profits into this account until it’s full.)

When an emergency happens (like a plumbing repair or an oversized tax bill that you weren’t expecting), you draw from this well. Then – and this is key – you refill it using the same process of setting aside a percentage of your monthly net profits.

Never Stop Growing

The great thing about investing is that the principles for success hold true over time. While markets change and economic conditions evolve, the foundational pillars highlighted in this article don’t budge. If you remember them (and consistently apply them), you’ll have more success as a real estate investor than most people ever dream of.