Getting your feet wet as a real estate investor? If you’re anything like me, the allure of real estate is tied to dreams of independence, passive income, and early retirement.
Those are some big dreams that most people don’t accomplish until late in their lives. So how can you buck that trend and escape the rat race by building a portfolio of rental properties?
The 20 Best Books for Aspiring Real Estate Investors!
Here at BiggerPockets, we believe that self-education is one of the most critical parts of long-term success, in business and in life, of course. This list, compiled by the real estate experts at BiggerPockets, contains 20 of the best books to help you jumpstart your real estate career.
Everyone has their own notion of what “financial freedom” means, so it’s worth pausing to clearly define it. In this context, financial freedom means having enough income from investments to cover your necessary expenses. In other words, your 9-5 job becomes optional because your financial survival no longer depends on it.
Break out your abacus — we’re going to do some primitive math to calculate the numbers for financial freedom.
Start by writing a list of your mandatory monthly costs: housing, utilities, groceries/food, car/transportation, car insurance, gas, average healthcare costs, average child-related costs. Joe Shmoe’s list might look like this:
- Mortgage: $1,500 (includes homeowner’s insurance and property taxes)
- Utilities: $150
- Groceries/Food: $500
- Car: $300
- Car Insurance: $100
- Gas: $100
- Average Healthcare Costs: $100
- Average Child-Related Costs: $300 (e.g. school supplies, occasional clothes, etc.)
That comes to a total of $3,050/month for necessities. Notice that the list does not include entertainment, meals out, shopping sprees, or bottles of champagne. Those are nice to have, but you can still be financially independent from your job without your investments covering those costs.
In fact, disciplined people can usually slim even their “mandatory” expenses down by living more frugally. But that’s an entirely different discussion.
Setting Targets: Short, Mid and Long-Term Goals
We now have a long-distance target, a finish line: income from a rental portfolio totaling $3,050/month. But how do we get there?
As the cliché goes, you complete a marathon by putting one foot in front of the other, one step at a time. If you start the race dwelling on how many strides you’ll have to take to reach 26.2 miles, it will overwhelm and dishearten you, and you probably won’t finish.
So while it’s important to set long-term goals and consistently remind yourself of them, it’s equally important to set milestones and short-term targets along the way.
Real estate investing and rental management require complex sets of expertise. They incorporate skills ranging from networking to accurate cost estimating to tenant screening to understanding broader trends to raising capital and more. These skills take years to master, but you can become passably competent in a matter of months with effort.
Here are some milestones to help you set a sustainable pace as you set off on the marathon to financial freedom.
Short-Term Goal: Your First Deals Over the Next 12-18 Months
Your first step? Find an experienced investing partner or at minimum a mentor. No matter how smart you are, you will make mistakes in your first few deals. Those mistakes can be extremely expensive, and they can be avoided by partnering with an experienced investor.
I’m still paying for some of my early mistakes. Be more responsible than I was.
If you don’t know an experienced potential partner, join a local real estate investing club. Attend every meeting. Network. Ask what kinds of deals the other members specialize in. Get to know as many other local investors as possible.
Your priority should not be making money in your first couple deals. Instead, focus on gaining experience and getting a rounded education. With an experienced partner, you should also make a little money, although be prepared for your partner to take the lion’s share of the profit and for you to do more of the work.
It’s easier to do flipping deals with partners with a clear exit strategy. That’s alright, so long as the deals are rental properties. Try to fill them with renters yourself and manage them yourself until you find a buyer.
Be sure to use these partnered deals to build a network of support personnel. You’ll need contractors of every price point, real estate agents who specialize in different neighborhoods, at least one title company, and above all, several sources of both short-term and long-term funding.
Your short-term goal? Two or three deals over the next 12-18 months.
Mid-Term Goal: Master Predictable Profitability
In order to reliably buy winners and avoid losers, you’ll need to master a wide range of arts.
Because most of us don’t have eight digits in our bank accounts, you’ll need to master raising money from other people. Don’t count on conventional financing — conventional mortgage lenders won’t lend to investors with more than a certain number of mortgages (that number is usually in the single digits).
Usually, this means you’ll need short-term financing from a hard money lender to buy properties quickly and have funding for repairs. You’ll then need long-term financing at a much cheaper rate.
Beyond securing multiple sources of funding, where will you find potential deals? Good investors develop multiple strategies for finding bargains. Master one method, then start working on another, always with someone experienced to offer guidance.
You’ll also need to develop an eye for property condition and repairs. Even if you buy turnkey properties, you still need to know how to identify common signs of trouble below the surface. Spend some time visiting properties with contractors, get a strong sense of what different types of repairs cost. You want to be able to walk through any property and estimate with decent accuracy how much it will cost to repair.
Since the goal is accruing rental properties, you need to learn how to profitably manage them. Manage all properties yourself at first — not only will it develop your skills, it will make you a better investor. You’ll gain insights into what kinds of properties attract what kinds of tenants, what amenities tenants will pay extra for, and what their priorities are.
Managing properties will also shatter some of your preconceptions and throw the cold water of reality in your face. I can tell you how important it is to send an eviction warning as soon as the rent becomes late, but most landlords won’t actually do it until they’ve spent six months in and out of court for the eviction process.
When you manage properties yourself, you’ll better be able to understand and predict expenses, helping you to better project cash flow and return on investment.
Your mid-term goal? Buy two to five properties/year in your second and third years in the investing game.
Long-Term Goal: Financial Freedom
You now have a handful of rental properties and can more accurately evaluate a deal and project cash flow. You should be able to identify good deals quickly and spend minimal time coordinating the purchase, repairs, and leasing of each one. You have a strong network of contacts, so a simple phone call should be enough to push through any one need.
Take a step back and look at your average monthly income from the rental properties. How much of your target figure does it cover?
About how much cash flow can you expect from each property you buy? A figure should be starting to clarify in your mind of about how many more properties you’ll need to buy to hit your target.
Continue building your portfolio and working toward your goal. It should be easier now than it was at first. Consider multifamily buildings if you haven’t already, but as always, do your first deal or two with a partner experienced in multifamily properties.
Now that you have a better sense of property management yourself, you can consider outsourcing it to a property manager. After all, the goal here is passive income, right? But I encourage you to manage your properties yourself as long as you can. It will continue to make you a better investor, and you’ll do a better and faster job of filling vacant units than a hired hand will.
As you get closer to your goal, a change in strategy may be worth considering. Sometimes less really is more, and you may be better off with fewer properties offering greater cash flow. Each property takes work to manage, whether it has a mortgage on it or not; if the goal is passive income, consider a few free-and-clear properties with stellar cash flow.
The math will vary based on your properties and your market. Imagine you could earn $3,000/month cash flow from 15 mortgaged properties or could sell ten of them and earn the same $3,000 from five free-and-clear properties. You’d now spend a third of the time on property management, and your accounting would be a third as complicated.
The downside? Loss of diversity: Each property makes up a greater portion of your income, so any given vacancy or rent default hits you harder.
Your long-term goal? The easiest way to pay your bills with your investment properties.
A Few Pitfalls
Goal-setting is personal and highly variable, but the broad strokes above should at least help newbies set reasonable milestones. In addition to playing offense in building experience and a portfolio, investors need to play a little defense to avoid common pitfalls.
As most people earn more money, the first thing they do is adjust their lifestyle and spend more money. You will never, ever hit your target monthly income if it keeps rising. As you start earning money from your rental properties, leave the money in your investment operating account. Use the money to buy more properties, not to buy more clothes or dinners out.
Diversity matters, too. Securities like stocks, mutual funds and ETFs provide separate sources of passive income, which is more important than you think. What happens if you’re relying on nothing but rental income and you have a terrible month with a high vacancy rate and several large repair bills?
With a securities portfolio, you can draw money from these accounts when you have a bad month and invest more money in them when you have a good month. This smooths the peaks and valleys of rental-based income.
Financial freedom is not just about buying up as many rental properties as possible. It’s about keeping your expenses in check, while building as much passive income as possible from multiple sources. Keep your eye on the big picture even as you strive toward smaller milestones, and soon enough working 9-5 will become a lifestyle choice.
How far along are you on your quest for financial freedom?
Success stories, setbacks, horror stories all welcome below!