Everyone says Real Estate is a passive investment. You own it, the tenant pays, end of story.
I had been a realtor for seven years before I started buying rental property of my own. Up until then, I would have agreed with “everyone.”
Why did I wait so long to start buying rental real estate? Even as a realtor I didn’t see the writing on the wall. I didn’t see the potential because I didn’t know how to analyze the numbers. I was selling to primary owners, not investors so it wasn’t something that I thought about.
Here I am, four years into buying rental properties and I recognize very clearly, that Real Estate investments are arguably the best investments out there. However, are they passive investments?
It depends what kind of real estate you’re investing in. If you’re buying rental properties, no they are not a passive investment.
However, if you’re buying REIT’s or investing in syndications, then those are passive real estate investments. More on those later.
Why Rental Properties are Not Passive Investments
No matter how you spin it, rental properties are a lot of work. You have to find the property, you have to make sure it’s the right fit for your portfolio, and you have to manage the property. None of these are easy alone and when you combine them all together it can be a ton of time and effort.
Below I’ll cover in detail the work that goes into rental properties and how you can minimize that work.
Find the Property
Just because its real estate doesn’t mean it’s a good rental investment. Finding the right property isn’t easy.
There are multiple ways to go about finding rental properties:
Hire a realtor
This is tricky. The vast majority of realtors don’t invest in real estate and have rentals themselves. The ones that do might have a property that they lived in and kept as a rental.
They don’t know how to run the numbers on properties to make sure they’re good investments. Beyond that, they don’t know how to help a client run the numbers to determine if it’s a good fit for that investor.
I’m not saying that hiring a realtor to help find an investment property is a bad idea. I’m saying you have to do your due diligence to find the right realtor and make sure they know what they’re doing.
It takes time and effort to find these realtors and establish a relationship. Then rinse and repeat until you find the right one for you.
Work with a Wholesaler
A real estate wholesaler is someone who goes out and finds the deals, gets them under contract and then essentially sells that contract to others to actually close on the property. I’m sure there are many in your area.
The biggest holdup people have with working with wholesalers is the idea that the wholesaler is getting a part of the profit. That’s true but that’s because they put in the work to find the deal. They found it and sold it to you.
Don’t underestimate the time, money, effort and knowledge that goes into finding the deal. Working with a wholesaler is basically outsourcing that portion of the job.
It takes time and effort to find these wholesalers and establish a relationship. They give first priority to the buyers who they’re familiar with and know will close on their deals.
Property Management Company
A lot of times you can find deals through your property management company. However, they’re generally bringing deals to people who are already clients.
My property management company has brought multiple opportunities to me before sending it out to others…at least, I think. Maybe I’m second or third on the list of who they’re sending it to. Either way, I’m seeing them before they hit the market.
That’s just it though, it all comes down to the relationship that you have and it takes work to build that.
For Sale by Owners
For Sale by Owners are just that. People who try to sell their properties on their own without the help of a realtor.
I’m sure you’ve heard of people doing this because people that do it won’t stop talking about it. However, the majority of people who attempt this fail and their property sits without selling. This is a great way to get a deal.
If you take this route, be ready to start dialing. It’s going to take a lot of phone calls until you land something that makes sense. In order to make those phone calls, you need their contact info. Which means, you’re going to have to subscribe to lists.
It also takes staying in touch with that seller over a period of time. Sometimes years.
List of Absentee Owners
Absentee Owners are owners who don’t live in the property. Which means they probably rent it out.
The fact is, owning rental real estate can be difficult and a flat-out pain in the butt. Especially if you don’t know what you’re doing.
The idea here is to catch someone at the right time. You can even go to the courthouse to find eviction filings. Those landlords are going through a rough patch. They might prefer to just offload that unit.
You can buy lists of absentee owners. If you choose to go this route, be ready to dial the phone and send mailers. You’ll also probably have to do this over an extended period of time in order to find some deals.
Just like many other ways to find deals, you’ll probably end up establishing some sort of relationship with the sellers before you make a deal happen.
Delinquent Mortgage Lists
Unfortunately, there are people out there who come into situations where they can’t pay their mortgage. You can buy lists with the contact information to these people and offer to buy their properties.
These are tricky because more often than not, these people aren’t excited about having to leave their homes. However, it may be a situation where selling can save them from having to foreclose, lose the property anyway and also hurt their credit.
This option of finding rental properties includes more dialing, mailing and some serious skill. You also need to have thick skin for calling this list.
You hear some stories that will tear at your heart strings. You’ll also talk with a lot of people who don’t want to hear from you.
Networking
This method is tried and true and really ties all other methods together. The more people you meet, the more opportunities you’re going to come across.
You can network with realtors. There are local investor group meetups. The options for networking are endless.
This takes a lot of time and effort. It also doesn’t happen overnight.
Driving for Dollars
With this method, you drive your target area and look for homes that appear distressed. Once you’ve found a home that fits, attempt to contact the owner. This could be as simple as knocking on the door.
However, the house could be vacant.
If the owner isn’t living in the house you may need to do additional paid searches. From there you’ll have to mail and call until you can reach them.
Auctions
This is a tricky one. In most situations that I’ve seen, you don’t get to walk the property and you only have a few pictures to go off of.
There are also people still living in the property in some cases. This could include unknown squatters.
Beyond that, a lot of auction properties will have to be purchased with cash. I don’t suggest this option for the inexperienced real estate investor. This option is a good way to close on a bad deal if you don’t know what you’re doing.
Every one of these options take a significant amount of work. You’ll come across people every now and then who just stumble across a good deal. However, that is extremely rare. More often than not it takes a lot of time, effort and money to find the deals that make sense.
Run the Numbers
Just because its real estate doesn’t mean it’s a good investment property. I get calls from clients all the time that are excited about buying an investment property. Until I run through the numbers with them.
Yes, investing in real estate is exciting. But you don’t buy real estate or any investment based on emotions. The numbers have to work.
The investment has to work for you and make you money in order for it to make sense. “If it don’t make dollars, it don’t make sense.”
How to Run the Numbers
When looking at real estate deals, you have to be able to find out quickly if they’re going to work or not. Those benchmark numbers will be different for everyone.
Some people bank on appreciation. Some just wanted to borrow money at low rates and use the leverage. Me, I want the cashflow. But I also like some appreciation and enjoy the tenants paying my mortgage.
A good way to find out quickly if it’s going to cashflow is by using the 1% method. If you’re buying a property for $300,000, it needs to rent for at least $3,000 per month. If it does, then you can dig deeper into the calculation.
Things that you’ll want to account for:
You’re going to have regular maintenance that needs to be done to the property. These items include appliance repair, clogged toilet, a new garage door opener, etc.
You’re also going to have larger items known as capital expenditures (cap ex) that will need to be done. These items could include roof replacement, window replacement, or a new HVAC. These are larger items that last a long time once they’re replaced.
These things need to be completed on the property to keep it in good working order, to keep in tenants in the property and to get it rented quickly when it’s vacant.
You will also need to account for times of vacancy. In between tenants you might have to do repairs. While you’re doing these repairs, you also won’t be able to market the property. You’ll still be paying the mortgage during this period but there won’t be any rent coming in.
Last but not least, you’ll want to account for a property manager. Sure, you might be ok with doing it yourself now but there may come a time when you won’t want to or won’t be able to.
You don’t want to be put in a position where you’re cashflow negative because you didn’t account for this in your initial calculations.
Running the numbers on properties takes time. This is something that your realtor most likely won’t do for you. Even if they do, you’ll want to double check them.
| Item | Expense | What's Included |
|---|---|---|
Monthly Mortgage |
$1,907 |
Mortgage Calculator / Incl. principle, interest, taxes & insurnace |
Maintenance |
$134 |
Depends on the condition of the property. For this calculation I used 7% of a months rent. |
Capital Expenditures |
$134 |
For larger things like roof, windows, HVAC, etc. Depends on the condition of the property. For this calculation I used 7% of a months rent. |
Vacancy |
$134 |
Depends on the type of property and location. For this calculation I used 7% of a months rent. |
Property Management |
$191 |
Even if you manage the property now, you want the option to not “have” to manage it later. 10% is common. |
Total |
$2,500 |
The property has to rent for more than this per month in order to truly cashflow. |
Managing the Properties
To those of you who manage your own properties or plan on managing your own properties. Peace be with you.
Managing properties can be an absolute mess. Depending on the property/properties, it takes a ton of time and effort. You also need to be patient enough to deal with it.
Below is a list of jobs that come along with property management:
- Advertising for new tenants
- Showing property to potential tenants
- Vet applicants
- Consistently update, improve and maintain the property
- Respond to maintenance requests
- Manage the finances
- Evictions
Managing your own property makes it 100% not a passive investment.
Find a Property Manager
Finding a good property manager is a job in itself. Brandon Turner recommends that you only buy in areas where there are six viable property management companies.
This is because they often times don’t work out. When they don’t, you need to be able to pivot quickly to a new one that will work for you.
If you’ve hired a property manager, you’ve probably learned that they’re not all great. In fact, most of them suck and can make your life miserable. It takes time and effort to find one that has the proper systems and processes in place to manage your property as an investment.
If you decide you’re going to hire a property manager, you’re still not in the clear. You can’t just hire the property manager and assume it’s all running smoothly.
Even when you have a good property manager, you have to manage the manager. You have to make sure they’re billing properly and maintaining the property to avoid larger issues down the road.
Below is a real-life list of issues that I’ve had with property managers from just three rental properties. Most of these issues coming from one property with one property manager:
- Lawn company mowing every week…in August. That’s unnecessary.
- Property manager unaware of issues with the property because they didn’t visit.
- Tenants had pets when they weren’t supposed to and the property manager wasn’t aware of it until I pointed it out.
- Issues with neighbors that the manager couldn’t handle and 100% should have been able to. So I had to.
- Tenants searched and found my phone number because the property manager wasn’t responding to them.
- I couldn’t reach the property manager.
- Property manager doesn’t provide proper preventative maintenance which causes larger issues.
- I had a tenant that left his windows open all winter. The problem there is…I pay for the heat. The manager was unaware of this until I pointed it out because he didn’t visit the property.
Don’t get me wrong, I believe that residential real estate is the absolute best investment out there. However, it’s not passive. Even when you have a property manager involved, it takes effort from you to make it work.
Passive Real Estate Investment Options to Look Into
REITs – Real Estate Investment Trusts. Companies that own, operate and or finance income generating real estate. They pool investors, similar to a mutual fund. The investors can earn dividends off of their investments.
Real Estate Syndication – This is another process of pooling investors’ money together to acquire real estate assets. With these investments, you have the sponsor or general partners who actively plan and manage the fund. You also have limited partners who contribute the bulk of the capital but don’t have a part in the day-to-day action. You generally need to be an accredited investor for this type of investment.
