Building a portfolio of rental properties is a step toward financial security. However, it is not as simple as just buying one property, and then another, and another . . . A well-developed portfolio begins with a specific financial goal and an organized plan to achieve it. For example, Zach has three children. The oldest one is in first grade. Zach wants to build a portfolio that will produce enough cash flow to pay for each child’s college education. Once the youngest graduates, Zach plans to redirect his goal toward building a retirement fund that allows him and his wife to maintain their lifestyle. Zach is aware of several options:
- Rather than purchasing properties, he could invest in real estate investment funds or real estate mutual funds.
- Zach could purchase properties, renting them for a specific number of years, and then reselling them.
- He could buy properties, remodel/update, and then flip in 3 months.
- He could purchase properties to own and rent out for the long haul.
- If he chooses number 4, Zach will have to decide which class of properties he wants to purchase –single–family homes, small apartment buildings, mega apartment buildings, commercial office buildings, commercial retail buildings.
Ok, now you are getting the picture –no two real estate portfolios are exactly alike.
Zach decides he wants 50% of his properties to be single–family homes and 50% to be multi-unit buildings (no larger than a quadplex).
He and his wife, Tasha, created a budget based on 80% of their combined income. The remaining 20% will be used for building their portfolio.
Year one and two – the entire amount will be stashed into a secure but accessible savings account. It will cover six months of living expenses should an emergency arise.
Year three and four: The plan to flip three homes each year for a total of six. The profits will then be used as down payments on rental properties.
They will continue to use 20% of their combined income, plus cash flow from rental properties each year, to build their portfolio. Their goal is to purchase four single–family homes and three multi–units during the next seven years.
At that time, the oldest child will be ready to enter college. The cash flow from the rentals should be sufficient to cover college expenses. For the next ten years, they will have a child in college, year four and year seven, they will have two in college at the same time. During these ten years, covering the college expenses will be the priority; if there is excess, they will continue to build a portfolio, but it’s ok if they do not.
Once the youngest graduates, they will re-evaluate the situation and create a plan for reducing the debt load on each property, setting aside for retirement and possibly increasing the percentage of their income used for living. They also plan to evaluate properties across the nation and add long-distance property investments.
This is an aggressive plan that includes designating a portion of their income from the rentals toward real estate consulting, property management, accounting, and legal advice.
The critical key is that Zach and Tasha:
- Established their objective. Which types of investments they wanted and how they were going to accomplish it.
- They developed a specific model. If you had access to their entire plan, it included other items, such as keeping their multi–units relatively close together to make inspections, tenant showings, etc., easier to manage.
- They created a specific ‘numbers game’ for their purchase plans. They also decided that they would work together the first two years while flipping houses – designating which roles they would cover and which responsibilities would be hired. Once they purchase their 3rd rental property, which will coincide with the youngest entering first grade, they plan to sign on with a property manager. This will allow them to be more involved in their children’s school activities and sports programs.
- In their plan, they designated on the high side when considering expenses, vacancies, etc. The idea is to make it more likely to be ‘surprised with an additional return instead of being hit with unexpected cash flow reductions. Speaking of cash flow, they made conservative estimates on cash flow and property appreciation.
- By creating a specific agenda and connecting with experts, they will be more likely to make wise purchases, gain reliable renters, understand the details such as tax benefits, and still have time for living.
As we said earlier, no two real estate portfolios will be the same. Some may have a less aggressive approach than Zach and Tasha. Others made be more aggressive or take higher risks. With expert advice, each future landlord can create a plan that suits their goals and objectives. If you need advice or someone to manage your properties, reach out to us at Rentals America.
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