For my investment minded friends,
Oddly enough with the housing market in such high demand, rentals are also at unprecedented levels. Here in Michigan we are in a shortage due to many factors. Possibly the biggest being the crash of 2008 caused largely by the housing market. Michigan was hit harder than much of the country, and due to this many builders went broke, and the ones that didn't left the state to find work elsewhere.
You may be wondering what this has to do with 2020? Well, because no one was building, and by the time the market corrected the population had exceeded the amount of homes available. This is a classic example of the law of supply and demand, and why we are currently in a sellers market.
Back to the topic, this is causing more people than ever to rent because they feel they can't afford to buy where they want to live. Although, on the contrary, with interest rates so low (3.8-4.5%) the typical buyer can actually purchase in the $150,000-$200,000 range, but unfortunately many haven't pursued this further than saying they can't, rather than speaking with their lender/realtor. This is where my investment minded friends can take advantage. Many of these renters will thoughtlessly pay your mortgage every month plus some, and if you are in the right position you could absolutely capitalize on this!
In this article we are going to go through just a few of the many options you have; from the simplest to more advanced methods used to capitalize in this booming (and god-forbid not booming) market.
1) House Hacking
House hacking is my personal favorite way to get into using real estate for cash flow. This would be best used for my younger, less attached investors. The basic principal is renting out rooms to your buddies, or hand picked tenants while living there yourself.
This is a fantastic way to start building wealth because 50% of the average persons income goes straight to their mortgage or paying rent. What if you could live for free though? Say you purchase that $160,000 house in a desirable rental area, and your mortgage is something like $1,000 a month. Well, that's fine because you rented out the other two rooms in your little 3 bed 1 bath home for $500 a month each.
There you go, your mortgage is paid for and you can start saving up money for your next investment while your property is appreciating at the low average of three percent APR, therefore building equity at the same time. We'll talk about how crazy you can get with this later in the article.
2) The BRRR Method
BRRR or Buy, Renovate, Rent, Refinance method is a tried and true method of creating wealth and cash flow with real estate. First of all, thank you Bigger Pockets for laying this out in such detail. If you haven't checked them out yet, Bigger Pockets is a fantastic resource. I listen to their podcasts every day to keep up on my education, and I recommend them to anyone. One goal of life should always be to keep expanding your horizons and to keep learning, you never know it all.
Anyways, the basic principal with BRRR is to use whatever method you have available to purchase a distressed/rundown property in cash. You don't really want to use a conventional loan to try this. Rather, do a house hack for awhile and save up and create net worth to get this done so you don't have interest rates eating away at your profits along with multiple title and realtor fees. Also, you want to buy a house that banks won't lend on. Use short term money like a home equity line of credit (HELOC), personal cash, hard money, etc. because the goal is to get your capital back out in a short period of time. Getting the right deal is the biggest make or break of this method.
The goal is to buy that $70,000 house in the $160,000 neighborhood, and dump another $50,000 into it by gutting and updating the whole thing. This has two purposes; first is if you do that then ideally you will already have around $40,000 in forced equity. Secondly, is that people love living in nicely updated new properties, and therefore will pay you more in rent.
Speaking of rent, the idea is to rent it for top dollar, so not only will the refinanced mortgage pay for itself, but you will also cash flow an extra $700 or so a month. The remodel is paramount in keeping this cash flow because with everything updated you shouldn't have a high level of maintenance eating into your profits since everything is pretty much new and not breaking down every month.
Lastly, you need to get that short term money back out from the initial investment, and turn it into long term money with low rates. This is where reinvesting comes into play. Banks love to lend on nice properties, and since you just renovated yours this should be no problem. Get that cash back out with a little extra to play with from equity and move on to the next property. This process is repeatable over and over again. Make sure to speak to your realtor and/or get an appraisal done for like $450 to find a deal with enough meat on the bone (equity) to make this happen.
3) Short Term/Vacation Rentals
Sadly for my friends here in Grand Rapids this isn't yet a very viable option. As of now, we have a city ordinance banning this type of rental unless you both live on the property and get one of the 200 elusive rental licences issued per year. This means the condominium owners and hotels have a monopoly on this industry. However, there are proposals going through state legislature to restrict city ordinances from having these ordinances, as well as regulating the industry for fair practice. Hopefully it goes through to protect property owner rights!
In the mean time, short term rentals work almost anywhere, especially in surrounding areas of convention centers, schools, vacation destinations, etc. Just make sure to do your research before jumping head first. The cash flow produced by these rentals is insane, easily doubling the mortgage on the property.
However, it's just as easy, if not easier to do ten of these properties compared to doing just one. This is because they require a higher level of maintenance such as cleaning and lockout calls. They have to be refreshed after every visitor, which should be 4-5 times a month, and you are going to want to pay a company to do this. You would also want to automate many of the services such as; online payment, coded locks, check-in, check-out, and simple questions. There are many apps available to help you create systems for all of these, and rental agencies such as Airbnb to make sure you stay booked! You're also going to want to make sure the property is furnished and cozy so make sure to account for those expenses when calculating if you want to do this.
4) Multi-Family Rentals
This is where the big boy (or girl) money is made, and easily attainable after you've established your single family investment portfolio. The problem when you go to sell all those little properties is that you will be paying all sorts of taxes in capital gains, but what if you didn't have to? All while increasing your cash flow and equity. That's where multi-family can come into play. These properties are literally designed to maximize cash flow, and their value is reflected in this with the capitalization rate.
(check out this link for info on capitalization rates https://www.thebalancesmb.com/how-to-calculate-capitalization-rate-for-real-estate-2866786)
The cool thing is you can basically trade all your little properties you have to manage for one big one without paying capital gains on it, and this new property will grow in value more while providing better profit margins with less maintenance. Just make sure you do your research right and remember how the market along with forced equity (renovations) can help you collect higher rents, and therefore increased equity.
Obviously there are endless ways to hybridize these as well as other avenues to follow. That's the beautiful thing about real estate, the options are endless and if you're in it for the long hall (and do it right) you can build an empire. Investing can be complex, so set up your systems and your team of professionals. Start small if you're new to this for the learning experience, and build right.
Happy investing!
Justin Rinks
Century 21 Affiliated
Realtor