How Investors Can Capitalize on Rent Fluctuation and Moving Trends

When looking for places to invest money, many people think that buying property, becoming a landlord and reaping the cash flow rewards would be a great place to start. Like any business, however, it’s not exactly as easy as you may think, and there are a lot of things to consider. Just chasing areas where rents may seem to be higher, doesn’t guaranty that you will be able to buy properties at a price that will make renting a profitable option. High rental demand can mean higher prices for rental properties, so first you need to understand the property leasing business.

How It Works

First, let’s consider how the process works. Simply, when you rent a property to someone else, whether that property is in a stable market like Eugene, Oregon or an expensive market like New York City, you want their rent to cover your expenses and provide cash flow on top of that.

Among your expenses as a landlord are:

• Mortgage payments
• Taxes
• Insurance
• Maintenance
• Rental Costs
• Major appliance replacement
• Legal

The good news is that some of these are controllable. The bad news is that if you don’t plan properly, you can lose money monthly.

Taxes

Whether you take out a mortgage to buy your rental property or whether you own it free and clear, you will still have to pay property taxes. These taxes are calculated according to your property’s assessed value, and usually, are adjusted every year; your municipality’s appraisal district handles this. Property taxes vary throughout the country, but a two percent yearly rate is not unheard of. Therefore, if your property is assessed at $200,000, your yearly property taxes would be $4000, or $333 per month. If you have a mortgage, these taxes will be escrowed, so the $333 amount will be added to your monthly payment. In a good economy, property taxes rise yearly, so you would have to also raise your tenant’s rent to stay even.

Insurance

When you become a landlord, you need landlord insurance. This policy will cover your property if it burns down, for example, but it will not cover your tenant’s belongings. Also, floods are not usually covered by landlord insurance policies, so that coverage has to be purchased separately. Landlord insurance is available from many different companies, and the price will vary. Insurance companies also tend to raise rates yearly, so you have to make sure that you watch billing statements carefully. Again, if you have a mortgage, landlord insurance will probably be escrowed and added to your monthly payment. This insurance can cost from $750 to $1500 or more per year, so you need to be sure that your proposed rent covers this expense.

Maintenance

Routine maintenance is a constant expense, and if you are not a good DIY handyperson, the costs can be steep. Just a standard drain cleaning service call can cost $150 or more, and if your property only cash flows $150 per month, that’s one month that will not be profitable. Some landlords use a third-party warranty provider that will cover certain costs like plumbing, electrical and HVAC repairs. There is a per-call fee involved--usually $60 - $75--but this can limit outlays for both minor and major repairs.

Rental Costs

It costs money to get a tenant. You have to place an ad, put your property on MLS, or even use a broker. It can also take time to get a tenant, and in some areas, it can easily take 30 days. When you do purchase your first property, you need to understand that cash will not necessarily flow in quickly.

When you get a tenant, you, of course, hope that they will stay for more than one lease term, but this is not always the case. And when a tenant does leave, the unit must be “made-ready” for the next tenant. Getting one tenant in the day after another one leaves is not always possible, so you have to be sure to factor in at least one month of lost rent when you have to fill a vacancy. Also, if you do you use Realtor or a real estate agent to list your rental, you will have to pay them a commission, and many times this can be 80 percent or more of one month’s rent. Therefore, a vacancy can be very costly.

Major Appliance Replacement

Again, by using a third-party warranty company, you can effectively blunt the costs of a furnace, AC, stove or refrigerator failure. We know of one landlord that replaced his tenant’s broken refrigerator with the unit from his home and replaced that one with a used refrigerator he found on Craigslist.

Legal

You need good leases that include your property’s rules and regulations. Downloading a lease from the Internet is not always a good idea, as some clauses may not even be legal in your specific state. It’s worth the money to get a good legal document, but again, it’s another expense.

Recap

We have shown that there are numerous expenses involved in renting your property to a tenant, and the most important factor to analyze is your monthly cost. Let’s look at a sample property. It’s a two-family house in a medium city in a nice neighborhood, and it can be purchased for $200,000. You have $50,000 to put down, so you will be financing $150,000. $150,000 at five percent –with a traditional 30-year mortgage—costs $805 per month. Taxes could be around $250, and insurance is probably $150 per month. Therefore, your fixed costs are $1205 per month. Factor in your home warranty for $80, a few service calls averaging $40 per month, one month’s lost rent for vacancies on each side for $200, and $100 per month for incidentals, and your fixed costs are $1625. If you can get $2000 in rent--$1000 from each side--your cash flow can potentially be $375 per month. There’s a little room for other expenses, so if you are comfortable getting a mortgage by putting down $50,000 in order to show a $375 per month profit, then being a landlord might be for you.

Of course, this is a simplified model, but it is obvious that unless you can buy properties with cash, your mortgage chews up a big chunk of potential profit.

Most successful landlords buy low, maintain their properties themselves, market them, rent them and service them without middlemen. They wait for years until rents rise considerably, and then they start to make money.

We know of a landlord in Austin, TX that bought brand new properties in a subdivision in the year 2000. He bought the properties for around $125,000. These were single-family homes. In 2000, he was only able to rent the homes for $900 per month. Now, however, the properties that he owns free and clear rent for almost $2300 per month, and even if he misses a month here or there, he is doing well.

The trick to making money buying real estate and renting it is not necessarily finding the areas that boast the cheapest or most expensive rental rates as these rates alone are irrelevant. You must keep your costs low and find opportunities that can give you the necessary spread between costs and rent in order to start making money.