As the U.S. real estate market continues to recover from the financial crisis of the mid 2000s, there has been a noticeable flow of capital moving back into residential investment opportunities. From the fix-and-flip model to the long-term rental/hold strategy, we’ve seen a steady return to real estate as a more tangible and stable investment. The players range from large institutional entities, backed with public and private equity, to entrepreneurial individuals looking to expand their portfolio.
More recently, a steady shift in return analytics have prompted investors to weigh the long-term benefits of renting properties versus re-selling. Generally, long-term rental properties can generate great, consistent returns, but one must proactively manage the process from acquisition to lease in order to avoid unforeseen costs and potential losses.
Here are six tips that can be helpful in keeping your pocketbook healthy when planning a rental business.
Tip No. 1: Identify your Target Markets
“Measure twice, cut once.” We’ve all heard the expression used in various scenarios. Rental investments are no different. Economic factors such as jobs, home formation and median income can all affect your rental property. Taking time to better understand an area can tremendously affect the performance of your investments.
Some investors only consider the markets in which they reside. But being open to new locations may lead to greater opportunities for those willing to take on some extra research.
There are many resources available to assist investors in examining a specific market. The internet is flooded with different consulting resources – some free, some for a cost. Don’t get stuck with the notion that your local MSA is the only feasible rental market that exists. Challenge yourself to spend some time investigating other areas.
Once a market is identified, drill down to specific neighborhoods. View school rankings and job information to isolate areas that will create the best rental demand and consistent income. Vacancy and turnover are absolute profit killers, so make sure you are diligent in identifying your target markets.
Tip No. 2: Don’t Underestimate Operating Costs
Rental properties are real, live operating businesses, and as such, carry operating costs. Budgeting for these costs is crucial in growing a successful rental portfolio. While gross yields and cap rates can be useful in analyzing an investment opportunity, it’s the net yield that will pad your wallet.
Don’t forget line items such as turnover costs, maintenance, capital expenditures, vacancy, property management and credit loss. Even if the costs are non-recurring, budget for them so that you can create a steady profit that you can count on over time.
Tip No. 3: Tackle Capital Expenditure Needs Up Front
You’ve located the perfect house with a great potential profit profile. The listing agent tells you, “The roof is 25 years old, but only has some occasional minor leaks that can be repaired fairly inexpensively.”
Don’t settle for this type of mindset and don’t downlplay potential problem areas in a home. Plan for the cost of replacing the roof up front. Procrastinating with rehab can lead to serious negative outcomes.
Tenants cannot be relied upon to notify you or your property manager of a small leak. That small leak can turn into extensive water damage and create a significant hit to your bottom line.
Be proactive with your homes – it is usually cheaper to do work up front rather than waiting for larger problems to occur down the road.
Tip No. 4: Find a Reliable Financing Partner
Instead of looking for a lender, look for a financing partner. It’s no secret that leverage is an easy way to expand your rental portfolio. But don’t settle for a bank or a private lender who wants to give you one loan and then disappear.
Conduit lenders, such as Colony American Finance, offer best-in-class solutions to assist in both the acquisition phase as well as the long-term hold period. They can extend credit beyond your immediate needs so that you know you’ll have financing available for future acquisitions.
Understanding your financing options is essential in creating levered returns that you can scale as you continue growing your rental portfolio.
Tip No. 5: Find a good Property Manager
Some investors chose to manage their own portfolios. In some cases, this works, and helps them with their bottom line. True growth, however, often requires a keen focus on scaling your business and expanding your rental holdings versus managing them.
Consider budgeting to pay someone to manage your properties for you. This will enable you to acquire a larger number of homes and will free up the time that you can use to evaluate other investment opportunities.
Work with your manager to put together a Policy and Procedures manual so that both parties are on the same page in regards to tenant screening, maintenance calls and other essential management activities. Understand and get access to the management software that your property manager uses so that you can also monitor your portfolio’s performance.
Tip No. 6: Keep Meticulous Records
The long-term success of your rental portfolio requires considerable effort and organization. It’s important to analyze historical factors such as maintenance, vacancy and credit loss. These indicators can allow you to make future decisions on rents, repairs and operations.
Keep clean historical records of all your rental properties so that you can easily access data and make informed decisions. Clean books will also make the filing of tax forms more seamless, ensuring that you realize the proper benefits and advantages of owning real estate.
Having a sound database of information is also extremely important when it comes to financing options that may be available for your portfolio. A little extra effort in the record keeping department can prove instrumental in increasing the profitability of your rental properties in the long run.
Rental properties can be a great way to generate consistent, long-term returns. They do require work, however, and being proactive in maintaining best practices can go a long way toward a building a successful portfolio.
While it may be tempting to cut corners at times, it’s imperative to stick to a plan and see it through. This can often be the difference between a highly profitable investment or a deteriorating money pit.
Although these tips are meant to be helpful, it’s also important to use your intuition and be nimble and in tune with the needs of your specific portfolio. With proper care and dedication, you too can grow your rental portfolio without breaking the bank.
About the Author
Dennis Spivey is Vice President at Colony American Finance.
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