How Risky is Investing in Long-Term Rentals?

Photo Apr 04, 1 48 56 PM

I am trying to buy as many properties as possible, because of the great returns long-term rentals provide.  I am also trying to help other investors discover the fantastic world of long-term rental properties.  However, I run into a lot of feedback from people who are scared to invest in Real Estate.  I hear; ” my friend went broke investing in Real Estate” or “my parents had a rental and it was a money pit up until the day they were forced to sell it”.  There are many horror stories involving Real Estate, but I have no doubt whatsoever long-term rentals are a great investment and I am not worried at all that I may lose money.

I am making over 24% cash on cash returns on my rental properties and I tell you how to do it in my guide. 

In another article I talk about how much money can be made with long-term rental properties.  Now that we know how much money can be made by investing in long-term rental properties.  I think most people will be very open-minded about getting into the business.  With potential for big money, many people automatically think there must be huge risk involved.  There is risk in Real Estate, just like any other investment or walking down the street.  If you have a long-term plan built to withstand market fluctuations, there is very little risk when investing in long-term rental properties.

Buy right

One key to a low risk rental strategy or any successful Real Estate strategy is to buy a property below market value.  Buying a property below market enables you to create instant equity, increase your net worth and protects you against a down turn in the market.

Lets look at rental property number 4 for an example.  I purchased the home for 109,000 in 2012.  I put about $35,000 cash into the property for repairs, down payment and other costs and my loan was about $88,000.   My break even was about $123,000 to get my full investment back out of the home.   That home was worth at least 145k fixed up and probably closer to 150k or more last year when I bought it.  Since I bought the home below market, prices would have to drop 20%, before the property would be worth less than what I had into it.  Prices would have to drop even further, more than 40% for the value to drop below my loan balance.  Even if prices nose-dived in the next year, I would be okay because I don’t need to sell the home since this property is providing about $700 a month in cash flow.

Cash Flow

I consider cash flow the most important factor in my long-term rental strategy.  I eventually plan to live and get rich off the cash flow from my rental properties.  When I buy a property and fix it up, I expect at least $500 a month in cash flow.  However, I am actually seeing much higher figures and in some cases I am getting $700 a month in cash flow.

With $600 to $700 a month in cash flow, my rents range from $1,100 to $1,400 a month.  For me to see negative cash flow, my rents would have to drop more than 50%!  It is possible that house prices could fall 20% or even 40%.  We saw that happen a few years ago, but rents did not drop 40% when the housing prices crashed.  In fact many places saw only minimal drops in rental rates, because rental rates are not based on the price of houses.  Rents are based on the supply and demand of rental properties in any given area.  If we ever see rental rates drop 50%, then either the economy has completely crashed or life altering event has changed a country or region forever.

Type of property you buy

I base my strategy on single family rental properties that are less than 50 years old.  The older the property the better the chance of a major repair needing to be done.  I have enough cash flow coming in to account for major repairs, but homes over 100 years old can have issues come up that could wipe out all equity.  It is rare, but a foundation or structural problem can make a property uninhabitable and cost tens of thousands of dollars to repair.  By purchasing newer properties, I lessen the chances of running into repairs that could wipe out my profit for a year or even two.  Here is an article on where to find a great deal on a rental property.

Then how did they lose so much money?

I won’t tell you it is impossible to lose money in Real Estate, it is easy if you don’t have a plan or are impatient.  It is not easy to buy properties below market value with great cash flow.  If it were easy, everyone would be investing in Real Estate and forget about the stock market.  The most common mistake investors make, is buying too high with negative or little cash flow and hoping a house will appreciate or rents will go up.  In this situation, the investor realizes it is not fun to constantly pay money every month into a house that may or may not appreciate.  He decides to sell and loses a lot of money, because he sold in a down market or sold too quickly to realize any gains.

Don’t be scared

If you buy right, have great cash flow, plan for the long haul and don’t buy a lemon then you will be fine.
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8 responses to “How Risky is Investing in Long-Term Rentals?

  1. Thanks for the post, Mark. You make valid points. I like your outlook – it makes me want to go buy more properties right away! Thanks for the motivation.

  2. Pingback: Purchasing Our First Rental Property, Part I | Monday Morning Landlord

  3. My wife and I just purchased our first property – small condo in a recently updated building. The unit inspected well, and it was a foreclosure, so the price was great. We were able to do this with minimal upfront cash (with regard to a major purchase, that is) and as our cash flow increases and our net worth rises, we hope to add more. I’m a bit tentative, though, about doing anything with the positive cash flow other than sock it away for repairs and updates.

    • Thank you for the comment!
      Congratulations on your first purchase. When I bought my first rental I saved up my cash flow for a while before I started reinvesting it into the mortgage. If you don’t have a lot of savings or reserves, it never hurts to save your cash flow.

  4. Been in the business for over 30 years. It does take being able to get along with people and work but if that doesn’t bother you it can be extremely rewarding.

    • Thanks for the comment Bob. I think people are scared about the management part of rentals, but you can always hire a property manager. They will eat into the profits some, but they can save a lot of time and headaches. After I reach ten I am either going to hire a property manager or start my own property management business.

  5. Pingback: Why 2013 is the Best Time to Invest in Real Estate | Invest Four More

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