Is That Inheritance A Cash Flow Investment Property?
When inheriting property, often times our first knee jerk reaction is to sell it off as quickly as possible and take the cash. That same property could actually become a cash flow investment property that builds up your income and savings for many years to come.
Sometimes the best decision is not to sell the house but rather to convert it into an income producing property.
Think about it. Since the property is handed over, there’s no initial purchasing cost or transfer tax to pay. That alone places you light years ahead of property investors. Right out of the gate you way ahead of the game! There’s another huge bonus to inherited property that I’ll cover later in this article.
Would you take $100 today or would you be willing to wait a year and take $1000? Most people would choose the $100 because we as a society are increasingly programmed to look for and take the immediate reward. Our access to and immersion with the digital world only exacerbates the problem.
Hyperbolic discounting refers to the tendency for people to choose a quicker small reward over a larger pending reward as the delay occurs sooner rather than later in time.
People are focused on the short term gain and rather than hanging in there for the long term haul. Studies have shown that since the introduction to personal computers our attention spans have drastically been reduced.
Real estate investing is a long game best played when employing a long-term strategy. In real estate, there is so much more to gain over time. In fact, few other investments can match it.
But, I Don’t Want To Be A Lanlord
I can already hear what many of you are thinking…I don’t want to be a landlord. I’m a landlord. Do you know how many times I hear from my tenants about a problem? Hardley ever! Maybe once a year. This is because I made sure to take care of any potential issues ahead of time. Also, if something needs repair, I don’t wait until it becomes a larger more expensive problem to fix.
If you’d rather not manage your property, there is a viable solution for that. Hire a property management company (PMC). Most PMCs generally charge 10% of the monthly rental. They handle everything for you including vetting applicants, collecting the rent and respond to tenant inquiries. In a nutshell, a good PMC is a buffer between you and the tenant.
If something needs repair, the PMC should contact you first and let you know the extent of the situation as well as the costs prior to work being completed. You can prevent major repairs ahead of time by making sure the property is in good condition before a tenant moves in.
Do your homework first. Research PMCs, check out the reviews. Make sure they are licensed and insured and that they provide documented proof of this! Make sure
What are rents going for in the area? You can get a pretty good idea through sites like Zillow.
Search for rentals that are similar in size, number of beds, baths. Start with a close radius, say 3 miles and then expand if you have to.
Look for a low and high range. Also, pay attention to the days on market (DOM). How quickly are similar size properties selling in that area? Less DOM means that the area is in demand.
Make appointments to go see actual rentals that are similar to your property in size, number of rooms, beds/baths. Take pics while your there to remind yourself of what renters in the area will expect. What type of countertops are there? How big/small are the kitchen and baths? How many closets are there? Also, notice the flooring and size of bedrooms. Take notes!
What are other landlords offering? Are they offering a free month of rent or low security deposit? These can be signs that they are having some trouble attracting tenants to the location.
Where’s The Nearest Starbucks?
Big retailers such as Aldi, Whole Foods, Starbucks, Trader Joe’s and other high-end end retailers and restaurants pay big money to identify up and coming neighborhoods.
Before they spend millions setting up shop, they want to make sure there are plenty of residents with disposable income to support their stores. Makes sense, right? Generally, if these type of stores are within a five block radius of the property, you’re in good shape.
Know The Neighborhood
Spend time in the area. Go to the grocery stores and the parks. Is there a hospital or community college nearby? How are the schools rated? Check out GreatSchools.com.
Try to get a sense as to what type of people will find that area attractive. A university town such as Ann Arbor, MI will demand higher rents but that also comes with a high turnover rate and lots of wear and tear along the way.
Personally, I’d be more inclined to gravitate to areas outside of university neighborhoods where families want to put down roots for years. It’s not at all unusual to have a tenant stay 5, 8 or even 10 years. On average, my tenants tend to stay 3-5 years.
Know Your Numbers
How much does it cost to hold on to the property? Compose a list of all expenses including utilities, property taxes, insurance, mortgage, HOA fees, etc.
Does the property require some repair? Make a list of any repairs and updates needed. Get the furnace and the air conditioner serviced. Get estimates for repair and add 10-15% for unforeseen issues that may come up. Set that figure aside for now. Do not include it in your holding costs. Consider this expense the cost of doing business.
Working It Out On Paper
Now that you have all your numbers. How much will you need to earn in rent to break even? What you want to do is look at the long term benefits. At what point will you begin to push past the break-even point and make a profit?
Rental leases can be tailored to cover all of your running expenses. That includes utilities, insurance costs
Deduct your holding costs from the estimated rent to determine your net monthly income. That’s extra money every month. Could you use an extra $500, $700, $900 or more monthly?
Now multiply the rent figure by twelve to calculate your annual gross income. Multiply your holding costs by 12 and then deduct that figure from your gross annual income. That figure represents your annual net income.
- Property Taxes $5000/year
- Insurance $800/year
- Water/Sewer $500/year (some counties require that landlords cover this charge).
In this example, holding costs are $6,300 a year. Why didn’t I include utilities? Because your tenant will have the utilities transferred to his/her name and be billed directly. If your tenants tend to be short-term (university students or Air BnB) then just make sure you charge enough to cover those costs yourself.
Holding costs of $6,300 a year, require minimum monthly rent of $525. How does this hold up against area rental rates? If similar properties are commanding $1000/month or higher, you’re in good shape. That’s an extra $475/month or $5,700 in additional annual income. But that’s not the best part. There’s a much bigger benefit just ahead and I’ll get into that in just a minute.
Now you can determine how long it will take to make back the repair costs needed. So the first six to twelve months could cover all holding costs and the extra goes towards your repair cost reimbursement. That’s fine and very common. Meanwhile, you still have an income producing asset that is growing in value. A huge benefit as you’ll soon discover.
Getting It Ready
- Clean it up. Give the place a good scrub and while you’re at it, you may uncover some other issues “laying in wait” to haunt you down the road.
- Hire a home inspector who will point out any critical things you need to take care of ahead of time. Take it from me, doing so saves you big down the road.
- Fix it up especially if it only needs some minor cosmetic improvements. Do the floors need refinishing? Are the carpets stained? Get new ones in a medium to dark color. Stay away from light colored carpets such as white or light beige. Keep them very neutral. Typically, grays work well in most rooms.
- If you’re handy with home repairs, then do as much of it yourself as possible. What you repair and improve now will pay you back.
Making It Cash Flowing
- Use an online system for vetting renters.
- Pay an attorney a flat fee to put together a rock solid rental contract that protects you 100%. Do this once and you can use it over and over again.
- Call the city where the property is located and ask them what inspections are required to obtain a Certificate of Occupancy. Some cities also require that you register the property as a rental. There’s usually a small charge for that.
Leveraging Your Asset
Remember I mentioned there would be another huge benefit to converting your inheritance into a cash flow investment property? Once you’ve got it tenanted and a property manager in place (optional), you can utilize the net worth of the property as equity.
Use the property’s equity to help pay for your child’s education or a big home improvement project you’ve been wanting to do. If you’re at or nearing retirement age, having that extra income will make a big difference. Rent plus equity is a beautiful thing once you understand how to leverage them.
Better yet, use the equity to finance one or two additional income properties that will help boost your income and build your net worth down the road. Just make sure the rent covers the cost of the loan payments, taxes, insurance, and management fees and still provides you with some extra every month.
Before you approach a lender for an equity loan on the property, you’ll need at least six months worth of rental income history first.
I have ten properties and counting. Do you really think I paid for each one with cash? Heck no! I don’t have to because I know how to leverage each one to finance the purchase of yet another and another.
Should you always leverage every property? Depends on how large you’d like your portfolio to grow, really. For instance, if by leveraging one property you can finance three more, you may decide that’s all you want.
Every month that the property is tenanted and paying the rent, increases your property’s value and equity. Down the road, you can use that same equity for just about anything.
My advice is to finance enough to put a minimum of 20% down on each new purchase you make, then finance the rest. So with 100K, you could easily purchase 2-3 additional income properties in the 80K-100K price range. Make sure you keep extra aside to cover your closing costs and any repairs needed.
The real beauty in all of this is you can repeat it over and over again. The golden rule of cash flow investment properties is to always make sure you are making more money, not less.
Hands down, this is by far the fastest and most secure way to building your wealth quickly. Investing in real estate is the best decision you could ever make. It’s not volatile the way stocks and bonds are. It’s also a physical asset you can touch. Why do you think all successful people invest in real estate? It’s not rocket science.
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Did I get any juices flowing in your mind? Can you see the potential? Have some questions? Feel free to write them here and I’ll be quick to reply. Also, don’t forget to check out my other related articles that I’ve inserted throughout this post.