Right off the bat I would like to apologize for my lack of consistency over the past several months. My focus has been taken up by many things, which I will disclose over the next several posts. The first focus has been finding and buying a 2 family home, moving and getting a tenant for our first rental property!! My wife and I are very excited about this next adventure that we’re taking on. So, I figured we could do a deep dive into why we wanted to pursue this path based on questions we got from friends and family.
Why Would you Ever want to be a Landlord?
This is something that I have heard a lot from friends and family since we began looking for a 2 family home. There are so many benefits to being a landlord, especially when first starting out as a homeowner.
Essentially, we are helping to keep the costs of our housing low by having others pay towards the cost of the mortgage. If we wanted to, we would only need to pay for any remaining amount costs above the rent, which would be a small amount of the mortgage and maintenance costs for the home. This would equate to approximately $500-600/month based on our current situation. Overall, meaning that we went from living in a studio apartment to a much larger 2 bedroom apartment with a yard for our for legged friend while cutting our costs in half. Sounds like a win to me!
Prior to this purchase, almost all of our assets have been in the markets. Adding the value of the home, plus the income producing capacity gives us a buffer if we were to find ourselves in a bear market early in our retirement. It also means that we will have to pull less $ out of those accounts to meet our minimum expense amount on a monthly basis.
Passive Income Stream
When I say that this is a passive income stream, I’m not saying that there is zero work involved in a rental property. We put in many hours upfront in finding the right home, crunching the numbers to ensure that it’s viable, getting the unit ready for tenants, screening tenants and now creating processes on the business end to make sure everything runs smoothly. However, once all of that work is done, there is comparatively little in a month to month basis that needs to be done.
How Did You Know You Had the Right House?
The answer to this is a combination of comfort level with math.
When I say comfort level, I mean how comfortable we are with different types of neighborhoods and cities. For example, the returns for homes in a lower class neighborhood tend to be higher, but since our plan is to live in one unit of the home, we don’t necessarily want to live in a dangerous part of town just to improve the investment. So, there is some balance that comes into play on a neighborhood we would like to live and where is a good location for an investment.
Another comfort level we needed to meet was in the amount of work that had to be done to the property. We wanted something that was mostly up to snuff since we’ve never owned a home before or attempted renovations, but we’re willing to put in some elbow grease to get it market ready.
The math involves several benchmarks that a property has to pass before getting to a point where we would want to make an offer on it.
The One Percent Rule
The entrance criteria for consideration on a property is the one percent rule. This rule state that the rent is equal to at least one percent of the acquisition price of the property.
Acquisition price = Purchase price + Cost of necessary repairs to get a tenant in place
For example, say the property that we bought was $90,000 and needed $10,000 worth of work before we could move in and rent the other unit to tenants. This would make the Acquisition price $100,000. Or to fill in the above equation:
$100,000 = 90,000 + 10,000
Now, that $100,000 home should bring in at least $1,000/month in gross rent. Our new home meets this criteria if we were to rent out both units.
The cap rate is a much more in depth calculation for a property and gives a better idea of it’s long term viability as an investment. Cap rate is similar to a return percentage on a stock. Here is the basic equation:
Cap Rate = Net Operating Income/Acquisition Price of your home
Let’s continue with the example I used above. Using the gross rent of $1,000 (12,000 annually) on a property, let’s subtract out the expenses. Expenses included in this would be water, trash, insurance, property management, maintenance and vacancy (assume 2-3 weeks between tenants to start). As a rule of thumb, we will say that all of these things add up to 50% of the rent every month.
$12,000 *.5 = $6,000 Net Operating Income
So, let’s fill in our equation from before:
Cap Rate = $6,000/$100,000 = 6%
6% Return on investment isn’t bad. Assuming that the home appreciates at the rate of inflation, the total amount of return on this property is between 8-9%!!! That’s pretty damned good!
The Wrap Up
Overall, we’re keeping our expenses down in the short term and saving more in the long term as our tenants pay most of the mortgage now and all of it plus maintenance and more in the future! All while we were able to move from a studio apartment to a 2 bedroom unit with a big deck and a yard for our pup. On top of that, we no longer have to pay for parking!
So far, we’ve had a couple of big expenses, but now our home is in much better shape for the long term. I’ll get into these major fixes in an upcoming post. Until next time!
These were the main questions that we heard from our friends and family when we were looking for our new home. What are your questions about owning a multi-family home? I’ve only been a landlord for a few months, but I’ll do my best with any questions you have. Let me know in the comments below!