What is passive rental income?<\/h3>\n
\u201cIt\u2019s what I call wake-up money, because when I wake up, I get paid without my needing to do anything,\u201d says Brad Korb<\/a>, a top Los Angeles agent and investor who owns 11 buildings and over 80 doors.<\/p>\n \u201cMy definition of passive rental income is owning a paid-off rental property that\u2019s filled with tenants who hand you rent checks every month, while you do nothing beyond owning the property.\u201d<\/p>\n Sounds perfect! But passive rental income is not completely free money\u2014there\u2019s no such thing.<\/p>\n It takes a lot of legwork and financial planning to find, purchase, fill, and pay off your rental properties before you reach the Easy Street of passive rental income.<\/p>\n Plus, the owner of the rental properties, you\u2019re the landlord. This means you\u2019ll occasionally need to handle maintenance calls and administrative tasks like accounting, or collecting the rent\u2014unless you hire someone to tackle those tasks for you.<\/p>\n But once you\u2019ve got your system in place, you\u2019ll soon be earning passive rental income with little to no effort on your end.<\/p>\n Read on to find out how.<\/p>\n If you\u2019ve got little experience in real estate beyond buying your own home, your first step needs to be assembling a team of experts experienced in real estate investing.<\/p>\n Partner up with a real estate agent<\/strong><\/p>\n The first member of your team needs to be a savvy real estate agent<\/a> experienced in finding ideal rental properties\u2014which takes some knowhow (see step 5). That experience also means they\u2019ll know how to handle the subtle differences between buying a primary residence and purchasing an investment property.<\/p>\n Plus, agents currently assisting investor clients\u2014or actively investing themselves\u2014will have a vast network of other experts you\u2019ll need on your side including seller\u2019s agents, contractors, financial planners, CPAs, and rental property lenders.<\/p>\n Join an investors club to make more connections<\/strong><\/p>\n If you\u2019re serious about making serious money in rental properties, you should join a local real estate investment club<\/a> ASAP.<\/p>\n \u201cReal estate investment clubs are basically social networking groups and they\u2019re a great place to learn from other investors like yourself,\u201d says Steve Behringer<\/a>, a senior broker with Kruse Acquisitions<\/a> and private real estate investor who currently owns 68 single-family rental houses.<\/p>\n \u201cThey usually meet once a week or so, and charge minimal fees like $10 or $15 per meeting. It\u2019s worth it because they bring in knowledgeable speakers who talk about things like seller financing, how to buy with a minimum down payment, or how to find affordable, reliable contractors.\u201d<\/p>\n If you start attending meetings like these before buying your first rental property, you\u2019ll meet plenty of people willing to advise, mentor, or partner with you. Plus, you\u2019ll learn a lot that\u2019ll help you avoid making costly newbie mistakes.<\/p>\n Mortgage companies aren\u2019t anxious to lend to inexperienced investors who haven\u2019t done their homework. So, the smart play is to put together your financial plan based on sound investment strategies and input from your team of experts.<\/p>\n Research and data go a long way toward boosting lender-confidence in your ability to become a successful investor. Ask your agent to dig up info on:<\/p>\n You\u2019ll need to price out how much your monthly and annual expenses will be, such as any HOA dues, potential repair and maintenance costs, insurance expenses, and property taxes.<\/p>\n \u201cProperty taxes on a rental house will basically be the same as you\u2019re paying on your personal residence, while insurance will be a little bit more reasonable on an income property. It\u2019ll maybe be 75% of what you\u2019re paying for your own home insurance,\u201d says Korb.<\/p>\n Put all this data together, and it\u2019ll provide a clear picture of the potential cash flow you\u2019ll have and the price point you can afford when purchasing your first rental property.<\/p>\n The financial data you dig up also needs to go to your CPA or financial planner. With these numbers, they can outline your short-term purchasing power and your long-term profit potential. This data demonstrates that you and your team understand how the rental property game works and will boost your chances for mortgage approval.<\/p>\n \u201cLenders look at your finances a little closer when you\u2019re borrowing to buy a rental property, because they figure that you’re not going to have it rented all the time,\u201d advises Korb. \u201cBanks will be more conservative with their lending practices for income properties because you\u2019re going to have a vacancy factor of 10% every year, whether you\u2019ve got a\u00a0single-family home or a multi-unit property.\u201d<\/p>\n The potential for vacancy and other unknowns are why most lenders expect or require rental property borrowers to have a significant amount of cash in reserves. Beyond the capital to purchase the house in the first place, you\u2019ll need to have around six months of rental income set aside. This money is there to cover the mortgage and other expenses whenever you\u2019re between tenants.<\/p>\n It\u2019s also there to help pay for any necessary repairs or refurbishments to get the property ready for new renters.<\/p>\n Your finances aren\u2019t the only factor in securing a rental property mortgage.<\/p>\n \u201cSome lenders will even look at your support system when deciding on your loan if this is your first venture into rental property investment,\u201d advises Korb. \u201cSo working with a real estate agent can help your chances at securing a loan because lenders know that agents know the business and will be working to help their clients succeed.\u201d<\/p>\n While your mortgage application is under consideration, take the time to set up your infrastructure so that it\u2019s in place before you purchase your rental house.<\/p>\n Separate your accounts<\/strong><\/p>\n For your first rental home, you don\u2019t need to form an LLC<\/a> just yet\u2014however, you should set up a separate bank account to handle your investment property transactions.<\/p>\n \u201cI would suggest setting up a separate checking account to handle your rental property finances,\u201d advises Korb. \u201cThat way, it\u2019s easy to track all of the money coming in from rent, and going out to pay the management company and so on.\u201d<\/p>\n This investment property-only account is the perfect place to keep your cash reserves, provides a place to deposit rental income, and keeps any rental property maintenance expenses separate. All of which will help when you report your rental income and deductions on your taxes<\/a>.<\/p>\n Enroll in a rent payment service<\/strong><\/p>\n When you\u2019re starting out with just one property, you may be able to get away with collecting the rent in person. But if your plan is to build up a portfolio of multiple rental properties, it makes sense to enlist the services of a rent payment service<\/a>.<\/p>\n Hiring a payment service will make it easier for your tenants to pay, and will also make your record-keeping a bit easier.<\/p>\n Alternatively, hire a property manager\u00a0<\/strong><\/p>\n You won\u2019t need a payment service if you\u2019re planning to hire a property management company<\/a> instead.<\/p>\n They will take care of rent collection for you and stay on top of maintenance repair requests and can even handle finding and vetting new tenants whenever your renters move out.<\/p>\n One of the best benefits of working with an investment-property experienced agent is that they can help you find the right rental home in the best neighborhoods. But that doesn\u2019t mean you can\u2019t keep your eye out for a good buy, too.<\/p>\n Consider real estate wholesalers<\/strong><\/p>\n While getting educated at your real estate investment club, you may just learn of a good deal on a rental property from real estate wholesalers<\/a> who also attend these meetings.<\/p>\n Wholesalers are in the business of finding sweet deals on off-market home sales because they know investors are willing to pay a small finder\u2019s fee for the info should the sale go through. That\u2019s because investors know they can save $10,000 or more if they can buy before a house goes on the market.<\/p>\n You might even find a bargain property at bank auctions<\/a> of foreclosed-on homes, or by scouring the internet for deals on government-owned homes<\/a>.<\/p>\n Never skip the inspection<\/strong><\/p>\n But don\u2019t let the lure of a good deal tempt you into buying a property without having it inspected first.<\/p>\n \u201cAlways do a home inspection on the rental property that you’re buying, that way you know how to budget for upcoming maintenance expenses,\u201d advises Korb.<\/p>\n \u201cThe inspection report will tell you the age and condition of the roof, the plumbing, the sewer, and the electrical wiring. Those are your four high-cost items that have the potential to be a major expense down the line.\u201d<\/p>\n Once the house is yours, it\u2019s time to get it ready for your first tenants. But don\u2019t go overboard on unnecessary improvements.<\/p>\n Remember, you\u2019re not the one living in the house\u2014and you\u2019re not even flipping it\u2014so you don\u2019t need high-end finishes or upgrades to increase the home’s value<\/a>.<\/p>\n But don\u2019t skimp too much, or the cheap materials won\u2019t stand up to the wear-and-tear of renters. After all, a tenant won\u2019t take care of a house as well as a homeowner would.<\/p>\n So, instead of picking finishes that look good, put the functionality and durability of your material selections first. Not sure which finishes to pick? Check out what other landlords are putting in their properties.<\/p>\n \u201cMake sure you go around and visit your competition. Go look at other houses for rent to see what the condition is inside,\u201d advises Behringer.<\/p>\n \u201cYou’ll find out that you don’t have to have a total rehab before bringing in a tenant. In fact, for the average investor just starting off, it may be better to buy a move-in ready property that doesn\u2019t need any rehab work.\u201d<\/p>\n Now that the house is ready, all you need is some renters.<\/p>\n Figure out your monthly rent<\/strong><\/p>\n But before you can line up your tenants, you first need to set the rent. For that, you can apply the 1% rule<\/a>.<\/p>\n This guideline advises that the amount of rent you charge should equal at least 1% of the home\u2019s value. So, if the house is worth $150,000, 1% of that is $1,500 a month in rent.<\/p>\n But note: \u201cThe 1% rule doesn\u2019t always hold true. With smaller, less expensive houses, you can get better than 1%, while with larger, more expensive homes it\u2019s harder to hit that 1%,\u201d says Behringer. \u201cHowever, It does keep you away from buying a house that’s too big or expensive, because you\u2019re not going to charge $5,000 in rent for a $500,000 house. People who can afford that are simply going to buy a house.\u201d<\/p>\n Research is your best bet to finding the sweet spot for your rental rate. Scope out the area and find out what nearby apartment complexes and rental homes are charging for properties similar in size and condition.<\/p>\n Just keep in mind that you can charge a bit more for a two-bedroom house with more square-footage and a yard than you\u2019d get for a two-bedroom apartment.<\/p>\n With your rent rate set, you\u2019re ready to list your property for rent, which your property management company can handle for you if you\u2019ve hired one.<\/p>\n Market the property to renters<\/strong><\/p>\n If you\u2019re doing it yourself, you can list your rental property online at any number of rental listing companies<\/a>.<\/p>\n Since you\u2019re renting out a solo property, you may need to spring to have the place professionally staged and photographed for the listing images<\/a>. But the good news is, you can use the same photos each time you rent the house out\u2014unless you\u2019ve made any drastic changes to the property.<\/p>\n The higher the quality of your listing photos and your listing description<\/a>, the higher your chances of getting a quality tenant into your property.<\/p>\n Vet your candidates<\/strong><\/p>\n It\u2019s every landlord\u2019s nightmare that they\u2019ll wind up with a renter who\u2019ll trash the place. So before you lease out your house, make sure you vet your potential tenants first<\/a>.<\/p>\n \u201cWe check all references and do a full credit check on potential tenants when they submit their rental applications. We find out what their credit looks like, if they\u2019ve been paying their bills on time, if they\u2019re really employed where they say they are, and all of that,\u201d advises Korb.<\/p>\n \u201cIf someone doesn’t have great credit, think twice about accepting them as a tenant. You don’t want to rent to someone who won\u2019t pay their rent on time or someone who can\u2019t afford to pay for any financial damage they do to your property.\u201d<\/p>\n Your new tenants moving in is a sure sign that you\u2019ve almost achieved the dream of passive rental income. All you\u2019ll need to do is collect the rent checks, and handle any minor maintenance issues that arise.<\/p>\n And if you\u2019ve hired a property management company, you won\u2019t even need to worry about collecting rent, making repairs, or even any bookkeeping. However, you will need to give your management company the freedom to spend some of your money on any maintenance emergencies that arise.<\/p>\n \u201cMost management company contracts include language to give them carte blanche to spend maybe $1,000 to $2,000 without prior approval from you. They need that authority to avoid extensive property damage in emergency maintenance situations, like roofing issues or a plumbing leak,\u201d advises Korb.<\/p>\n \u201cSince I\u2019m earning income from so many properties, I give my management company carte blanche to spend whatever they need to spend on maintaining them. And the companies I work with have never abused that.\u201d<\/p>\n Now that all the financial details are handled, you can relax and enjoy the passive income\u2026<\/p>\n Although, you can\u2019t expect to retire off of the income of just one rental property.<\/p>\n It takes a lot of work to find, buy and rent out one rental property, and the money you\u2019ll earn from the rental income (after paying the mortgage, etc.) isn\u2019t enough to make the hassle worth it.<\/p>\n However, now that you\u2019ve got your team, financing, and infrastructure in place, it\u2019s easier to add a few more rental properties to your retirement portfolio. Within a few years of successfully renting out your first house\u2014you\u2019ll be ready to buy the next one with the proceeds from the first.<\/p>\n The equity of one property fuels more purchases<\/strong><\/p>\n While your fixed-rate mortgage stays the same each year, inflation allows you to increase how much you charge in rent each year\u2014typically by around 5% annually<\/a>. This means that every year your income increases while your expenses stay relatively the same.<\/p>\n Plus, the longer you make mortgage payments, the more money goes towards paying down your principal loan balance<\/a> rather than toward interest. The more debt you pay off, the more equity there is in your rental properties.<\/p>\n Real estate is also an appreciating asset<\/a>\u2014which means that your investment property will probably be worth more than you paid for it several years down the line. The more it\u2019s worth, the greater the amount of equity you can borrow against. With a home equity line of credit<\/a> (HELOC) you can pull out the money you\u2019ll need for a down payment on a second property.<\/p>\n Use the rental property domino effect<\/strong><\/p>\n Now you\u2019ve got two houses that are appreciating, your mortgage debts are decreasing with every loan payment, and your rental income continuously increases.<\/p>\n In a few more years, you\u2019ll be able to pay off the HELOC on the first property. Then you can take out another on the second property to help finance your third, and so on.<\/p>\n However, you can reach a point, where the number of properties you own will change the way you strategize your rental property portfolio.<\/p>\n \u201cAfter I hit 10 rental properties, I couldn’t get a 30-year fixed mortgage anymore,\u201d advises Behringer.\u00a0 \u201cAt that point, lenders consider you a professional investor, so you\u2019ll have to switch to getting a commercial loan.\u201d<\/p>\n The appeal of passive rental income is enough to entice even the most risk-averse retirees into trying their hand at becoming a real estate investor.<\/p>\n While it\u2019ll take a lot of effort to get started in rental property investing, once you\u2019ve got your team, financial backing and infrastructure in place, you\u2019ll have all the tools you need to build passive rental income into your retirement portfolio.<\/p>\n Header Image Source: (Nichlas Andersen\/ Unsplash)<\/em><\/p>\n","protected":false},"excerpt":{"rendered":" Retiring with rental properties is a big undertaking but experienced investors help us put together this step-by-step plan for aspiring property tycoons.<\/p>\n","protected":false},"author":37,"featured_media":11353,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"content-type":"","cybocfi_hide_featured_image":"","footnotes":""},"categories":[429,319],"tags":[],"class_list":["post-11352","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-retirement","category-selling-advice"],"acf":[],"yoast_head":"\n![\"\"](\"https:\/\/www.homelight.com\/blog\/wp-content\/uploads\/2019\/07\/how-much-can-you-make-flipping-houses-door-1.jpg\")
<\/a>Follow these 9 steps to get there<\/h2>\n
Step 1: Build a solid investment team<\/h3>\n
Step 2: Develop your property investment strategy<\/h3>\n
\n
Step 3: Secure financing<\/h3>\n
![\"A](\"https:\/\/www.homelight.com\/blog\/wp-content\/uploads\/2019\/07\/rental-income-for-retirement-desk.jpg\")
<\/a>Step 4: Set up your infrastructure<\/h3>\n
Step 5: Find the right rental property to purchase<\/h3>\n
![\"A](\"https:\/\/www.homelight.com\/blog\/wp-content\/uploads\/2019\/07\/rental-income-for-retirement-kitchen.jpg\")
<\/a>Step 6: Prep the property<\/h3>\n
Step 7: Rent out your rental property<\/h3>\n
![\"\"](\"https:\/\/www.homelight.com\/blog\/wp-content\/uploads\/2019\/07\/rental-income-for-retirement-repair.jpg\")
<\/a>Step 8: Maintain your property<\/h3>\n
Step 9: Building your investment property portfolio<\/h3>\n
Are you ready to become a real estate rental property tycoon?<\/h3>\n