The Key to Long Term Success

The key to long term success – forming a real estate team

This is part 4 of 4 on how my family got started in real estate

Closing day is finally here. You now own a rental property! Congratulations!! For me the process would end here: I close on the property and immediately hand the keys over to my property manager. For those of you who want to manage the property yourself there are several great books out there dealing with being a landlord. If you were really lucky you bought a home with a tenant already in place who wants to stay in the home when ownership transfers, like my third rental home. If that isn’t the case, as soon as the house is yours you can start showing it to prospective renters. If you need to do some repairs or renovations that will take less than a month, you can attempt to rent it out while fixing it up to help reduce your vacancy time. Signs in the yard, ads on craigslist or a video tour of the house on YouTube are all great free ways to advertise your property.

I have learned a lot by purchasing rental properties and personal homes over the past decade. Each time I get ready to buy another home I continue to learn more about the process and feel more comfortable with the terminology. My tolerance for mortgage debt has also increased as I understand more about safely using leverage. I wanted to pay off my first two rental mortgages as soon as possible to get rid of debt and have high monthly cash flow. However, after I ran the numbers I realized I would actually get better cash flow if I used that money as a down payment on the next home instead of paying off the mortgage.

Now I want to create something similar to a debt snowball, but instead of using any extra money to crush my debt I’ll use extra money to save up for my next purchase. With each new home purchase I generate more monthly income which allows me to save for the next house faster than I could before.

If you want long term success I think you have to avoid several common mistakes some real estate investors make:

• They don’t do improvements in between tenants. This is the perfect time to spruce up your home and add value to your home. Simple things like a fresh coat of paint, refinishing hard wood floors or replacing old appliances can be done in between tenants and might allow you to rent the home sooner and for more money on the next tenant.
• They don’t save for emergencies. I have a Betterment account labeled “rental home down payment.” It is a basic 60/40 allocation investment account where I save for the next rental home and it serves as my emergency fund in case a major item like a roof needs to be repaired.
• They underestimate renovation costs. When a contractor gives you an estimate, remember that is what it is, an estimate! You need to plan for paying 15% more and pray you end up paying 15% less.
• They don’t have good customer service. A great way to reduce costs is to reduce turnover between tenants. Fix things in a timely manner. Return phone calls quickly. Allow them to have pets.
• They don’t plan. With my first rental I had no goal; I enjoyed the monthly income and thought very little of it. Then in 2010 I decided to make real estate investments part of our retirement plan. I set a goal of having 20 rental units by 2025. The goal is measurable with a defined timeline which makes it achievable.

The two things people never seem to have enough of are time and money. Why not leverage both? Create a team that works for you so all you have to do is say I am ready to purchase my next rental home and they jump into action. This is an area I am working on. For our first home, which eventually became a rental property, I simply walked into a house that was for sale by owner, liked it and offered to buy it for the full purchase price. I had no idea how to do any of it. I didn’t understand the mortgage process, what being a homeowner meant in terms of basic home maintenance, nothing! All I knew was the mortgage payment was going to be less than my rent was so it seemed like a good deal. I had graduated from college and had a steady job, so buying a home seemed the next logical thing to do. Once we moved out of that house and rented it out, we added the first member of our team – our property manager. So now our team has a company that screens tenants, advertises the home for rent, performs basic maintenance like checking fire extinguishers and cleaning out gutters, coordinates repairs, and handles any legal actions if needed. On our second property we added a home inspector to our team. We found a great inspector who really took the time to explain issues in a house, what was a priority for repairs and what could be done down the line, and gave estimates for how much you could expect to pay to fix issues. On our third property we added a real estate agent who specialized in rental properties and managed over 20 of her own in town, a local mortgage company and a real estate lawyer to handle all the paperwork at closing. Now when I am ready to purchase a house I let the realtor know my parameters and she comes back with a list of options, I get pre-approved with the mortgage company, we walk through our final choices with the home inspector, the lawyer closes the deal and files all the paperwork with the city, and then I hand over the keys to the property manager to rent. My goal of early retirement becomes closer to reality each time we purchase a rental home and the amount of work I have to do each time is getting less because I have built up a system and a team around it.

The final topic I want to talk about is how to structure your new business. The areas you need to consider are taxes, obtaining finances, and liability. For taxes there is very little benefit to setting up your real estate holdings as a C or S corporation unless you are doing property management or flipping houses where you have complex business structures and multiple employees. If it is just you or your spouse the income from rental properties is just passed through to your total income and taxed at your current tax rate.

To finance your properties, banks want to lend to a reliable person with stable income -- it is harder to get a loan approved as a small business because the risk is perceived higher. Some people purchase a property and then transfer it into an LLC later; check the terms of your mortgage to see if you can do this. For some loans, this transfer would trigger a clause called “due on sale” which means you would have to pay the bank the full amount due upon transfer. Also moving your properties into an LLC might make it more difficult to refinance later if you need to pull some cash out of your rental property.

Liability is the most common concern for real estate investors. They don’t want to get sued. Some people place each home in a separate LLC, some people place a few homes in an LLC, and some investors do not use an LLC at all. I am in the final camp; we only use umbrella insurance for our liability protection. We have liability coverage on each home’s fire insurance policy and on top of that we have an umbrella policy covering all of our homes and cars. Whether or not to use an LLC is highly debated because some people feel it does not provide any real amount of protection. Everyone agrees that the small amount, in my case $275 a year, needed for umbrella coverage is mandatory for any landlord and the most affordable route for liability protection.The other ways to reduce your liability are to maintain your homes and remove hazards as soon as possible, fix tenant issues in a timely manner, check fire extinguishers and smoke alarms yearly, screen your tenants and check with their previous landlords for issues, and follow your lease obligations – all of which should be done tirelessly anyway to protect your investment and cash flow.

I certainly don’t claim to know everything about real estate, but I am always looking to learn more and crunch the numbers to evaluate properties. The members over at biggerpockets have done thousands of real estate deals ranging from buying a single family home every year like to me, to flipping a house every month, to buying 100 unit apartment complexes. Whatever type of investment you are interested in you will find others there that have similar goals and questions.

There is so much I still have to learn and with each new home purchase, book or website I read, I learn a little bit more. There is huge potential out there, especially with the young millennial generation that doesn’t want to buy a home and get locked into an area for long. Those people do need a place to live and someone needs to own those homes and make money off those renters – it could be you! Hopefully my series of articles explaining the path I have taken in real estate will give you some insight into the opportunities that are out there. Good luck!