This was originally written as a guest post for Joseph Hogue’s MyStockMarketBasics. It was published on November 27th, 2018.
Many people dream of having a multi-million £€$ real estate portfolio that churns out positive cash flow every month. The allure of this lifestyle is obvious: little work is required to produce a steady flow of predictable income at regular interval.
Property as an asset class has a very important role in my overall investment portfolio. I’ve been a landlord for over 5 years and I have managed $3 million worth of properties. I will share with you the 6 most profound lessons I’ve learned along the way.
Please note: my experience is purely on residential properties, not commercial. However, from the research I’ve undertaken, the principles below are equally applicable.
Lesson 1: Clarify your objectives
Every investment decision stems down to 3 goals:
- To grow the capital;
- To generate a reliable income stream;
- A combination of both
The attainment of these goals and the extent (i.e. how much) are driven by the risks you take on, namely
- Capital risk: loss of your input capital;
- Income risk: loss of income level and periodicity;
- Liquidity risk: inability to rapidly turn the asset into cash without suffering a significant drop in value.
Here’s an example comparison between cash, stock, and property to illustrate the different risk profiles:
The bottom line is that property can produce a steady income stream at a decent yield, whilst enabling the underlying capital to grow at a similar pace to economic growth if you can accept the reduced liquidity.
As a result, I see its income and capital growth potential to sit somewhere between cash and stock and accept reduced liquidity as a risk for its return profile.
Lesson 2: Work out the maths
At the end of the day, the reason for investing in property is simple:
- You’ll end up with more cash in your pocket at the end of each month.
- It diversifies the investment away from financial assets.
This means before I decide to buy, I always run the following calculation:
Net Income = Rent – Mortgage Payment – Monthly Expenses
That end result must be positive to start with. More importantly, the annual net income as a % of the purchase price represents the yield (or return) on my investment.
I’d like to see it above 4%.
This is because if it’s lower, then I might as well buy some blue-chip dividend stocks and not bother with the hassle associated with buying and managing a house!
Lesson 3: Finding a reliable and financially sound tenant is priceless
Gwen from Fiery Millennials has a rental and apparently she put tenants in there without asking them to undertake background and credit checks. I can only take my hat off to her figurative “balls”. In all seriousness, it just goes to show what a genuinely kind person she is. Perhaps Gwen would consider coming over to the UK and fix the DSS tenancy discrimination issue that is rampant in the UK rental market.
On the other hand, the credit risk of my tenants ranks highly on my risk radar for rental properties, probably right after Armageddon and before the next financial meltdown. This is because your tenants are the producers of that quasi-passive income that allured you into making the investment in the first place. Without them, there will be no £$€ flowing into your bank account at the end of the month.
Thankfully there are plenty of service providers that can provide comprehensive tenant screening service and assign risk profiles out there. They are also affordable too and you may even be able to ask your tenants to contribute to the cost.
In the UK, I use the service offered by OpenRent, which is an integrated online letting agency and rental management platform. I am not too familiar with the US market but a quick Google indicates plenty of service providers. I found this review which is helpful.
Please use them!
Lesson 4: Take advantage of bank loans when you can
There’s a Chinese proverb that says “banks only want to lend you an umbrella when it’s sunny”. It essentially refers to the fact that banks only want to lend money to people who could most afford it. This is a cohort of people with a steady and usually above -average paycheck.
If you are one of these lucky guys, then take advantage of the offer, especially when the mortgage rate is at a historic low (I’ve just refinanced mine onto a 10-year fixed mortgage at 2.39%).
The beautiful thing about the competitive mortgage market these days is that at such a low rate, the long-term capital growth of properties should already outpace the cost of borrowing. That’s before rental yield being taken into consideration.
Furthermore, having a mortgage can free up your capital to be deployed for other investments, which should generate returns far in excess of the mortgage rate. This reduces the opportunity cost of your capital.
A word of caution: NEVER overstretch yourself and always save up plenty of financial cushions for these repairs and void periods. You might not have tenants to pay you rent but banks will not wait and will want their money back, every month. Personally, I will not let my loan-to-value ratio creep above 60% and my mortgage payment is no more than 50% of my monthly rental income.
Lesson 5: Insurance, Insurance, Insurance!
I used to think insurance is simply one of these inevitably boring admin chores I had to endure to keep my conscience clean. That was until when one of my rentals was broken into in the middle of the night and I was faced with a £3,000 repair bill to fix a double-glazing door (who’d have thought these buggers were that expensive)!
Thankfully my insurer covered the entire bill and arranged for workmen to be on site to replace the broken door, without a single fuzz! In return, I only had to pay £200-worth of insurance premium every year. Talking about getting the bang for the buck.
There’s simply no better way of saying this: get the appropriate insurance for your property!
I’ve always believed that property has an essential place in every diversified investment portfolio. Hopefully, by following these tips, you can have an equally prosperous financial future.
Can’t afford to invest in properties? Fear not. Sometimes small means agility and be able to diversify easier. There are hundreds of real estate investment trusts (REITs) covering everything from residential to shopping mall and farms. They trade like any other stocks and pay regular dividends. They combine the best of stocks and properties. In fact, I have written extensively about what to do if you want to invest in properties but can’t afford the entry price tag. Do check them out.
Do you own a rental? What’s your experience been so far? I’d love to hear about them. Please do comment way.