Do you currently have sufficient income and assets? Are you looking to build long-term wealth? Buying and holding rental property can be an effective and conservative approach for investing in real estate. Acquiring a portfolio of rental properties can be carried out on a small scale over a number of years or it can if can be ramped up over just a couple of years. It all depends on your financial resources.
In order to have neutral cash flow (money going out = money coming in) in the central Texas area, I suggest planning to put 30% down. The 30% number is higher here than in other areas of the country because our property taxes can run as high as 3%. You also need to factor in the costs of a property manager (approximately 6% - 8% of the monthly rent) as well as reserves for cost of leasing, vacancies, maintenance and repairs when calculating monthly cash flow. Please check with your accountant regarding maximum yearly allowable passive tax losses.
The one "fly in the ointment" with this strategy involves recent changes in Fannie Mae & Freddie Mac guidelines which restrict investors to a maximum of 4 investment properties. It may be possible to find a local lender willing to hold the loans rather than reselling them, but that scenario needs to be dealt with on a case-by-case basis.
The best strategy I have ever seen for building a portfolio of rental houses worked as follows:
- Arrange for a source of down payment & repair funding by using funds from a HELOC (Home Equity Line of Credit) or borrowing from a 401 K.
- Buy property for cash at a price such that the combined purchase price and fix up costs do not exceed 70% of fixed up market value.
- Lease property to tenant with a minimum of a one year lease and a rental income that is sufficient to support neutral cash flow after obtaining a 70% loan to value mortgage.
- Finance the property at 70% of appraised value after the tenant has moved in.
- Replace total original cash outlay from HELOC or 401K.
- Start looking for next property and repeat.
The problem for most people is acquiring the initial cash to start the process. One possible source is the often large amount of tax-free equity that is received when long time owners sell their primary residence. Instead of plowing it all back into a bigger, better, larger home, consider putting $125,000 - $150,000 aside as seed money for your rental portfolio. Remember that ideally you want to buy for cash and also pay for the fix-ups in cash and only get the loan after you have a tenant in place. Doing it in that order will give you the maximum appraisal and thus the most financial flexibility.