What is the best way to build a rental property portfolio?
Scaling your rental property portfolio is one of the best ways to increase your passive income stream. First, consider and appreciate your goals as a real estate investor.
Take a hard look at the time and effort that you want to invest into building your real estate empire. Is this something that you want to set and forget? Or are you interested in a more hands-on approach? The answers to these questions will dictate some of your next steps. Property management takes effort—how much time do you have to devote to your new portfolio?
Here are a couple of strategies that you may want to consider to build your real estate portfolio.
The ABC investment strategy
There are generally three types of properties:
Property A—This property is ready to rent. It is in good condition, well-maintained, and has all the necessary amenities to start renting immediately.
Property B—This property is maintained and has the basics, but it could use simple renovations, limited updates, or some minor repairs. You could delay the work to rent right away or you could perform the updates and get a higher level of rental income.
Property C—This property needs a lot of work because it is in bad shape. It is not ready to rent right away, and you will need to invest time and money to get started. Some of these properties might be available through a foreclosure sale or auction.
With the ABC investment strategy, you have a mix of each property type. Property C may have the most significant return on investment, but it also carries the most risk. On the other hand, Property A will generate immediate income, but it might take longer to recoup your initial investment.
The stack strategy
If you already have one rental property and want to expand, you might employ the stack strategy. This strategy involves owning one rental property for the first year to help you figure out how to be a landlord. You learn the ropes and earn experience in the world of real estate.
After some time, you add new properties at regular intervals. Each year, however, you double the number of properties, which results in quick expansion and an increase in profits.
To grow your portfolio quickly, you may consider multi-family homes or apartment buildings. These properties are great investment choices because they quickly provide several sources of income. They may ultimately lead to faster growth because of the immediate increase in income.
Look for areas with good job markets and high rental demand to help increase profitability.
What are the pros and cons of owning residential versus commercial rental properties?
Residential real estate investments include both single-family homes as well as multi-family units. They are generally any property that is zoned for residential use. Commercial property, on the other hand, includes a wide range of "other" properties. As a rule, anything non-residential is considered commercial.
The benefits of commercial real estate investment
Longer rental terms—Perhaps the most important benefits of commercial real estate investment is that leases with a commercial tenant are often longer than residential leases. As an investor, you can count on lease revenue for a long time without having to renegotiate the lease or find a new renter.
Triple net leases—Many commercial leases are also Triple Net Leases, which means the renter takes care of not only utilities, but also maintenance, insurance, and property taxes. These leases are much more "hands-off" for landlords.
Higher return on investment (ROI)—Commercial properties may have a higher ROI compared to houses or even smaller multi-family properties. You can often integrate small improvements, such as covered parking or other amenities that commercial clients might pass onto customers, that will increase the rent.
The drawbacks of commercial real estate
Problems with lease termination—Although long-term leases have their advantages, they have drawbacks too. For example, if you have a problem tenant, you might have trouble forcing them out as soon as you want. The eviction process requires certain notice periods, cure periods, and more.
Demanding renters—The renters who occupy commercial space are generally more sophisticated than residential tenants. That also means they can be more demanding. Commercial leases may be more complex and might require the assistance of an attorney to help negotiate terms each time the lease is up for renewal.
Increased risk—While accidents can happen anywhere, they are more likely to occur on commercial properties, where there are more visitors.
The benefits of residential real estate
Demand—Everyone needs a place to live, so demand for residential properties is higher than commercial properties. Generally, the residential rental market is less susceptible to market fluctuations and economic swings.
Several exit strategies—Residential properties may have more flexibility compared to commercial properties. You can get out faster compared to commercial properties in most cases. It is also easier to adjust to the economy because residential properties generally have shorter leases and a larger pool of renters.
The downsides of residential real estate investment
Relative risk—While residential real estate may have less risk, it still has some risk. Turnover costs and vacancies are the priciest risks. Individual renters are also less likely to take care of a property, which can cost more in maintenance.
Many areas have residential rental controls that cap how much you can charge for rent, limiting increases from year to year regardless of the current market. For example, during COVID-19, many residential renters received special protections to avoid removal, even when they could not pay their rent obligations.
Adding value can be a challenge—There are only so many things you can do to increase a residential property's value so that you generate more rental income. Remodeling and expanding parking are two avenues. On the other hand, commercial tenants are more willing to pay for extra services that might add value for their customers.
How can I manage multiple rental properties myself?
The more properties you add to your portfolio, the harder it becomes to maintain them on your own. However, it can be done. Many investors choose to enlist a rental management company to stay on top of these tasks, but you can also take on this responsibility yourself.
Below are a few tips to incorporate:
- Create a formal process for tenant complaints.
- Use the same lease renewal process every year.
- Perform regular property inspections.
- Use rental payment reminders and enforce late fees (accepting online payments might address this issue).
- Screen tenants with extensive background checks before they start renting.
Generally, being proactive will help your investment portfolio demand less of your time. Get additional tips about managing your rental property on your own.
What kind of help can I get managing my properties?
A property manager or management company can handle maintenance, finding tenants, and more. They will generally oversee all or part of your rental business for a flat fee or a percentage of the rent payments each month.
You can also enlist individuals to help with your business, such as a bookkeeper, maintenance person, or real estate agent to help attract tenants. Reliable tenants may also serve as on-site managers in exchange for reduced rent or other forms of compensation.
Each property owner is different, and only you can decide how involved you want to be. You may also evaluate when you need help.
Are there tax considerations for owning multiple rental properties?
In general, you can deduct and credit the same items for each rental property, regardless of how many you own. These include things like:
- Real estate taxes.
- Maintenance and improvements.
- Mortgage interest.
- House depreciation.
Although you can address all of your properties together, it might make sense to incorporate or form an LLC. Specifically, if your income gets high enough, it can force you into a higher tax bracket. You can avoid some of those consequences by incorporating your real estate business. Learn more about taxes and incorporating your rental business.
As you grow, it is a good idea to have a real estate lawyer to answer your questions. You can always reach out to a Rocket Lawyer On Call® attorney for affordable legal advice.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.