By S. Jack Butala

We all want financial security.

Buying a house and renting it out has not changed since the beginning of time.

The basic concept has been the same; shell out some money up front to control the property, then get it back every month forever.

Done correctly, your children and their children can enjoy the monthly income.

Super simple, right? Yes, it is. 

Then why does is fail so often? Because everyone wants a piece of your pie.

Here’s why it fails (the successful way is at the bottom of this post):

After a local real estate agent sits down with a home owner and convinces them to list the house for top dollar, they jam at least 6% of that price into the cost on the buy side. You, the investor pays for that fee. Never let an agent tell you that the seller pays their fee.

Lenders are in business to convince you that the lowest down payment possible is best with the lowest interest rate and the longest term. Mortgage agents and the lenders are fee driven. After the papers are signed, they are on to the next deal. They are naturally motivated to sell you the mortgage with the most fees built in (new rules have made this much better for investors, but loans are still expensive by nature). This drives up the cost of owning the rental.

Where there is a lender, there is an insurance agent and a government backed mortgage insurance policy in some cases. Lenders require that you pay for specific insurance coverage to protect the home they own. Until the loan is paid off, they own the property, not you. You just control it.

Where there is a lender, there is an inspector who is paid to find problems in your real estate deal.

Where there is an inspector, there is a contractor who is paid to fix problems, many of which don’t exist.

After you buy the house, you have to rent it to a tenant. The real estate agentwill charge you about 10% or one month’s rent to find a tenant. They can find an awful tenant because they are motivated to get paid quickly so the first and worst person that shows interest, moves in. The real estate agent can also use the wrong lease document because by law (in many states) they are licensed and are forced to use the document that is one sided toward the tenant, not you the land lord/ owner/ investor (this is not their fault, they simply have no choice).

Then you need a property manager. That costs 10% of the rent collected or a fixed fee of several hundred dollars every month. This is after the one time “set-up” fee.

So after all that, here is what you have:

An overpriced house that is over leveraged and straddled with debt, rented by a sub-standard tenant under a one-sided lease document. And it’s all under the control of a property manager who is not motivated to prevent the problems that can be avoided in a rental house.

By the time the tenant moves in, everybody involved has made all their money. Except you.

The whole system is set up to help you fail at being a real estate investor in SFRs.

Here is the successful way:

Choose a neighborhood or market you have identified as a life-long rental market (if you are new, spend two months on this – not joking). This is different for every investor. Some people are great with inner city rentals. Some do well in bed room suburb communities and some in urban metro markets. It’s a personal preference.

Locate a house to buy from the actual owner by using direct mail. There is a right way and a wrong way to do this, so do a lot of research (if you are new, spend at least a few months on this topic – not joking). Hint: Don’t use colored letters or post cards.  Send actual offers.

The whole key to real estate investing (from Donald Trump to Sally Duplex), is finding undervalued, off-market property. This is true with sky scrapers and unwanted rural vacant land (our niche), and everything between.

Buy the property with cash. If you don’t have the cash, sell the opportunity you just found to someone who does have cash in that market. You can find them on craigslist if you search something like “cash for your house,” or “we buy houses,” or “local rehabber buys your unwanted home.” Make sure you clear at least $10K per deal.

Call them and say “I have a super undervalued house that I’d like to buy, but I just don’t have the money to get the deal done and I don’t want this opportunity to go to waste.” They will drop everything to listen to you.

Repeat this until you have enough cash to buy your own property.

At this point, not only do you have the cash, you have the experience. You know how to source undervalued real estate.

You know how to source undervalued real estate (not a typo – a repeat for emphasis). I have made a life-long career out of this simple concept.

So you are ready to buy a rental:

• 1) Locate an owner and negotiate a good / great price for yourself.
• 2) Put together an agreement on the back of a cocktail napkin that says I agree to buy and you agree to sell your property located at X address on Y date. I can back out for any reason by Z date, after that, we close the deal no matter what.
• 3) Check out the quality of the physical property with someone you trust and who knows about how houses should be maintained (buy them a case of beer), and close the deal through escrow on time and as you and the seller agreed. Always keep your promises.
• 4) When you open escrow, post the property for rent in Craigslist.org and Zillow and Trulia (use Postlets.com). If the house needs to be remodeled, wait for the finished pictures before you market it. If you chose the right market and its priced right, it should take less than 7 days to find the perfect tenant.

Hint(s): The pictures and the presentation need to be perfect on the internet. Choose the right tenant upfront. More bedrooms are always better. 4 bedroom SFRs stay rented in the worst of times and best of times for the most money. Women and families run by women are better tenants than men nearly every time.

• 5) Close the deal. You should have a signed lease with a hand-picked tenant in place and a move-in date. An affordable and appropriate insurance policy should be in place the day of closing. Set up monthly payments for the property taxes at the county (don’t wait to pay all at once when the bill comes). Same with the water bill. These are the two costs associated with the property that can potentially place liens on the asset you own.
• 6) Collect the money. Forever.

The only people involved in this transaction other than you and the seller were the escrow agent and the handy man you paid in beer (and a phone call to the insurance company who already insures your car and house or apartment).

You avoided, the team of real estate agents, the lender and the lenders contracted agents, the government mortgage insurance policy, the insurance policy required by the lender(s), the licensed inspector, the licensed contractor, the property manager(s), and years of bad tenants selected by the property manager.

Congratulations. You have put yourself in a position to succeed no matter what happens.

Let’s say your tenant moves out after they destroy the house. No problem, you clean it up, spend a little money, and rent it out again. If it takes two months, it’s not fatal to the investment because you have no monthly mortgage payment.

Let’s say you lose your job and need money fast. Sell the house for any amount you want. There’s no lender to approve your price.

Here’s the math:

If you did everything correctly you should be depositing (net) between $800 and $1,200 per month on this SFR (depends on the market). Let’s use $1,000. And you know how to pick great tenants so they are in for good and pay on time.

So you are collecting $12,000 a year in rent on an asset you purchased for $120,000 (all costs included). Rent goes up 3% a year and the value of your asset goes up about 11%. These are not my numbers. 3% is approximate and tied to inflation and 11% is about the historic value increase of free standing residential property nationwide.

ONE SFR RENTAL

Year one:

Accumulated Rent collected: $12,000

Asset Value: $120,000

Year Five:

Rent collected: $63,710

Asset Value: $182,168

Year Ten:

Rent collected: $137,567

Asset Value: $306,964

FIVE SFR RENTALS

Year one (5 houses):

Accumulated Rent collected: $60,000

Asset Value: $600,000

Year Five (5 houses):

Rent collected: $318,548

Asset Value: $910,842

Year Ten (5 houses):

Rent collected: $687,833 / $78,286 every year

Asset Value: $1,534,822

In just 10 years, you are in the position of potential retirement and so are your children.

We have chosen to accomplish this with unwanted rural vacant land.

You are not alone in your real estate ambition.